Covered call writing and selling cash-secured puts are stock option strategies with primary goals of income generation and capital preservation. Most of us are conservative investors who seek to beat the market on a consistent basis while minimizing portfolio risk. This is one of the mission statements of the BCI methodology.
In the past few weeks, I have heard from many of our members (international members as well) who are concerned about a severe market correction and want to be prepared in case a significant downturn does take place. I do feel that a review of some of the management techniques we can implement in the event that the market corrects to a significant extent is useful at this time.
Sell in-the-money call strikes and deeper out-of-the-money put strikes
Using in-the-money strikes with covered call writing is our most commonly used approach to protecting ourselves against share depreciation. We are generating downside protection of the time- value of the premium, a perk paid for by the option buyer, not us. If we sold a $30.00 call on a stock currently trading at $32.00 for $3.00, our initial profit is 3.3% ($1.00/$30.00) and that profit is protected by the intrinsic value ($2.00/$32.00) = 6.25%. In other words, our share price can drop by 6.25% and we would still generate a 3.3%, 1-month return. Similarly, selling deeper out-of-the-money put strikes will provide more protection to the downside.
Use low-beta stocks
Our premium watch list gives beta stats and historically low-beta stocks tend to outperform in bear market situations. Use this as a secondary parameter as lower implied-volatility is more important than the historical-volatility reflected in beta stats.
Lower monthly goals using options with less implied volatility
As an example, lower your monthly goals for initial returns from 2%-4% to 1%-3%. This means that the implied volatility of the underlying securities is less and therefore results in lower risk.
Use Exchange-Traded Funds (ETFs) instead of stocks
ETFs or exchange-traded funds are baskets of stocks with some going up and some going down. As a whole, and generally speaking, these securities have less implied volatility (IV) than individual stocks. In our weekly ETF Reports for premium members we also give IV stats for our ETFs and you can tailor your portfolio to your personal risk-tolerance and overall market assessment. Here, too, I would lower my initial time-value return goal range to perhaps 1-2%.
Buy protective puts
A put will give us the right, but not the obligation, to sell our shares at a certain price. When used in conjunction with covered call writing, the strategy is called the collar strategy (detailed in this book). It usually is set up by selling out-of-the-money (OTM) calls and buying out-of-the-money puts. Here’s an example:
- Buy BCI at $48.00
- Sell the $50.00 OTM call for $2.00
- Buy the $45.00 OTM put for $1.00
Our initial options credit is cut in half but we are protected against a catastrophic price decline below $45.00. Here’s what this trade looks like when using the BCI Collar Calculator:
- Initial time-value return is 2.08%
- Maximum return is 6.25%
- Maximum loss is 4.17%
Sell cash-secured puts
We can enter our covered call positions “at a discount” if we are bearish on the overall market. Here’s an example:
- BCI is trading @ $42.00
- Sell the OTM $40.00 put for $1.00 = 2.6% return
- Each put contract is secured with $3900.00 in cash [($40.00 – $1.00) x 100]
- If there is a price decline below the $40.00 strike, we purchase BCI at a cost basis of $39.00 ($40.00 strike – $1.00 premium)
- We can now write a call on this stock and select a strike based on all the parameters detailed in my books and DVDs.
I call this the PCP Strategy or Put-Call-Put Strategy. To better visualize this strategy here is a diagram taken from the back cover of my book, Alan Ellman’s Selling Cash-Secured Puts:
One of the advantages of covered call writing is that it can be molded and modified to meet the challenges of current market conditions. An elite and educated option-seller, which is where we want all members of the BCI community, will change the strategy approach based on overall market assessment, chart technicals and personal risk tolerance. One size does not fit all.
Your generous testimonials
Over the years, the BCI community has been incredibly gracious by sending our BCI team email testimonials sharing stories as to what our educational content has meant to their families. Moving forward, we have decided to share some of these testimonials in our blog articles. We will never use a last name unless given permission:
I’ve been a premium member for a few months now and have really benefitted from your weekly mailings, videos and advice. Thank you for finally getting me on a path I’ve been seeking for a long time.
Sacramento Options Traders webinar
Covered Call Writing with 4 Practical Applications
Sunday July 19th
12:30 – 4 PM
Login information to be sent to registered members (club and premium members)
Market tone data is now located on page 1 of our premium member stock reports and page 8 of our mid-week ETF reports.
I recently finished reading your book on puts (excellent!) and really like the pcp strategy to enter a covered call writing trade. Does this strategy require special approval? I already have approval for covered calls?
Thanks a lot.
This varies from broker-to-broker. Some may require a higher level of option trading approval for put-selling. Others, like Charles Schwab (see screenshot below), have both covered cal
kl writing and selling cash-secured puts at the lowest trading level (“0”).Check with your broker rep the steps needed to sell cash-secured puts.
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Is there a specific or range % option premium you choose? I noticed your examples in or around 3%. I started viewing your videos on YouTube as recommended by someone..
Welcome to our BCI community.
My target for an initial time-value return goal range for 1-month options is 2% – 4%. I’ll go as high as 6% in strong bull markets but never higher. In my mother’s more conservative portfolio, I use 1% – 2%. Each investor must find the appropriate range for their personal risk-tolerance and target goals.
1, when selling covered calls is there a sweet spot in terms of annualized return?
2. Do you every do out 45 – 60 days if the premium is not there?
2a. Do you have a cheat sheet which contain more or your basic rules 🙂
3. I have stock purchase plan with my employer – for 10 years the stock has simply sat and accumulated shares and will continue to do so monthly as long as I am there. I am interested in you covered call strategy for this ticker. The ticker is RCI.B – any suggestions you would have on how to best tackle this would be great. 75% is the value is outside my retirement plan 25% is within the plan, i.e. getting called away could have some tax implications, The shares should arrive in the next two weeks.
Just thought I would comment on some of your questions…
***** Cheat Sheet;
** Look at Resources / Downloads section of the member site when you log in. There several useful Flow graphs covering actions one can take when writing Call and Puts.
** Use the Google search in the blog to see the answers Alan and others give to trade scenarios. Alan repeats the guidelines often.
*****The process of selling a call against stock you already own is called Overwriting. There is a Blue Hour Video on Portfolio Overwriting (#6) and a book on it (Covered Call Writing Alternative Strategies) which Alan recently published. You have to follow certain rules to avoid the chances (not guarantee) early exercise, which will take away your shares and create a taxable event.
Glad you like our videos and welcome to our BCI community.
Let me add these remarks to Mario’s spot-on comments:
I could not find ticker RCI.B. I did locate RCI.BK which has no options and RCI which does. When we have a security with options that we want to retain for tax reasons, we decide on an annualized additional return above appreciation and (in some cases) dividends. We divide that annual return by “12” to get our 1-month initial time-value return goal. A reasonable goal may be 6% per year ort 1/2% per month. We check the option-chain for out-of-the-money strikes that meet our goal. For traditional covered call writing, our goal will be much higher for most option-sellers..
I prefer Monthly options over longer-term options with Weekly options a second choice. Not all stocks have Weeklys associated with them. Important dates to factor in are earnings and ex-dividend dates. Explanations are found in the material Mario alluded to.
RCI.B. in Canada
RCI in USA
RCI is currently trading near $40.00 If we seek an additional 6% annually from option premium ( as one example), we would look for 1-,month returns of 1/2%. In this case that would compute to about $0.20. We check an option-chain for out-of-the-money strikes that return our target premium. Dates to watch are the earnings report and ex-dividend dates. RCI does not have Weekly options.
your explanation and indications are perfect.
In my opinion, the BCI methodology is the best system for conservative investors as myself.
The “collar system” is really very protective, but reduces the ROO significantly, and complicates the execution of our trades. Insurance is expensive, and I prefer the BCI exit strategies to protect my diversified portfolio.
I believe that ETFs are not the best solution at the moment because the COVID scare plus the election expectations are affecting each segment and each individual company differently and temporarily, and the ETFs places them all in the same basket.
My risk tolerance places me right inside your 2-4% ROO range, with the 6% maximum return limit ruling my every trade.
This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member site and is available for download in the “Reports” section. Look for the report dated 07/02/20.
Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:
Starting this week, The BCI team has added additional information and improved the format of our weekly ETF Reports, thereby enhancing the quality of these reports and making them more user-friendly and time-efficient. Here is a link to a video overview of these new upgrades:
On the front page of the Weekly Stock Report, we display the Top 10 ETFs and the Top 3 SPDR Sector Funds. They are sorted using the 1-month performances from the Wednesday night ETF report and the prices from the weekend close.
Barry and The Blue Collar Investor Team
I want to ask how safe is to hold cash and equities in US brokerage accounts?
You refer holding 50% of your account in cash at the moment. Do you use one broker or do you split your funds between several brokers? I’m from Europe, so I’m not familiar with American laws and investor protection you have here, but in EU 100,000 EUR is insured and everything above that is not. If you have 300,000 EUR in cash and want to be fully protected you must hold funds in 3 different banks, 100,000 EUR each. I use Tradestation as my broker and almost all my net worth is here, sometimes I wonder is it safe enough to put all eggs in one basket. To login to my Tradestation account I need just a simple login/password combination and this is very basic protection compared with the banks in Europe I use and I believe it can be hacked easy. I also have no idea what will happen to equities and cash if broken will go bankrupt. I believe equities will not be lost as broker acts as a holder only, but what about cash? Does holding large cash pile exposes us to additional risks? I know some big funds use short term US treasuries instead the cash. When you refer to holding cash, do you hold actual cash or you buy T-bills?
I’d be glad to hear from other members as well to know how you deal with this issue. Do you use one broker, or are you using few? How do you mitigate the risks?
The cash and securities in major US brokerages are protected (with some limitations) by the Securities Investor Protection Corp (SIPC), a non-profit organization. I use multiple accounts for my trading.
Here is a link to a video that will explain this organization. Just click the arrow to view:
My broker is Schwab, as it is the only one that accepts Brazilian residents, my case, and I feel very safe with them.
Schwab has a login alternative where you are required to answer a specific question which you will have to give after entering your password, as additional protection from hackers.
But nothing in this world is 100% safe, and therefore my trading cash is only 25% of my total assets. The rest is in 3 different banks, plus real estate.
A new Blue Hour webinar (# 14) has been added to your member site.
Scroll down on the left side for title “Converting Non-Dividend Stocks into Dividend-Like Stocks by Selling Call Options”
The BCI team, will continue to work tirelessly to provide content for our members that assist in elevating returns to the highest possible levels.
Would like to know your opinion regarding the collar Put strategy in such volatile and unpredictable stock movements. Almost once a week such moves are occurring. Hence this protective Put strategy,I think is of utmost importance these days.
Sell a 30-45 days Expiration OTM cash secured Put and buy a protective Put (collar),
And after some green days(say 7-10 days) buy back the short Put for a profit, then wait for some red days (they are happening quite regularly) and sell the long Put for a profit as well.
OR short another cash secured Put against the long Put.
You are looking at two different strategies. The first is the Collar trade that I referenced in the blog article. With the Collar, you buy an out-of-the money (OTM) put to hedge/protect your downside risk with a covered call. The Collar can be used in a number of scenarios, including a bearish market.
The other strategy you mention, a “Collar Put” strategy appears to be a form of a Bull Put Spread (BPS). The BPS is typically used in a neutral to bullish market. With a BPS, you want to price to increase and move away from your short put. The rest of the adjustments you describe are adjustments to the BPS.
While your approach can work, it will take a lot more attention to the trade to make sure that a sudden drop in price below your short put may cause you to have a 100% loss in the trade. In this case, your max loss would be:
[(Difference in strikes) – (net credit)] x (# of contracts)
Spread trading is outside the scope of this BCI site at this time.
Alan & Barry
I got a little confused today when using the Mid Contract unwind tab. Here is the trade and the question:
6/08/2020: I bought 200 shares of KWEB on at $56.50
6/8/2020: STO 56 strike @ $1.65 with a 06/19/20 expiration
6/19/2020: KWEB went up to about $61.00 on expiration Friday
6/19/2020: Rolled out-and-up.
6/19/2020: BTC the $56.00 strike @$5.90
6/19/2020: STO the $61.00 7/19/20 expiration at $2.90
7/06/2020: BTC the $61.00 strike at $6.95 as the stock was above $67.00
7/6/2020: Sell the stock @ $67.64.
What should I have used as the original stock purchase price and the original option strike price in the unwind calculator?
I had 2 BTC orders on this covered call. The $5.90 BTC and the $6.95. I would think this change my cost basis and then there was 2 different STO strikes, $56.00 and $61.00.
We are dealing with 2 different types of calculations throughout this series of trades. First, we have calculations that guide our active trading decisions. Second we have calculations that define our overall trading results. here are the 3 cost-basis amounts during active trading:
6/8: $56.00 (price of shares – intrinsic-value of 1st premium)
6/19: $56.00 (value of shares at the time of rolling- our contract obligation to sell at $56.00)
7/6: $61.00 (value of our shares prior to closing the short call- our contract obligation to sell at $61.00)
Once the shares are sold, we can analyze our total result:
Option side: Net debit of $8.30
Stock side: Net credit of $11.14
Total net credit: $2.84 (original investment was $56.50)
This results in a 1-month return of 5.02%
Calculations for tax purposes in non-sheltered accounts are treated differently.
Today’s selloff in the last 1/2 hour of trading may have created some rolling-down exit strategy opportunities. I received notice from my broker that 10 of my contracts were closed based on the limit orders I set based on the 10% guideline. All positions are still trading above the breakeven but by closing the short calls, I am in a position to generate additional time-value premium.
This is not luck. Generating additional premium from our position management techniques is a result of the intersection of preparation and opportunity. The preparation was setting the BTC limit orders and the opportunity was the market decline in the last 1/2 hour of trading.
These exit strategies are difference-makers. How often do you check your accounts to see if the BTC trades are filled? When do you plan to roll-down?
Most brokerages offer a notification service. I have mine setup to be notified by email when trades are executed.. I had several of those yesterday. I plan to roll-down today.
Below is a screenshot depicting what we see when these BTC limit orders are executed.
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This happened to me last week when 3 of my short PUTs (MSFT, BA, and ULTA) were closed at 20% of their original value due to my BTC orders placed following your guidance.
I do receive eConfirms by email from Schwab, but I had already seen the trades because I watch the trades first thing every day.
I did immediately use the freed-up cash to sell new PUTs for 07/17/20 expiry (XOM) and (ULTA rolled up) with ROOs above 2%, and placed new BTC orders for them at 20%, which I changed to 10% on Monday.
I expect/hope this options cycle will be very favorable to me.
Made my day, Roni. Thanks for sharing.
Once a successful exit strategy is executed prior to expiration, we immediately enter a BTC limit order based on the new rolled-down strike price’s premium. There may be more exit strategy opportunities prior to expiration.
As an example, in the screenshot below, I rolled the (6) XLE $40.00 strike to the $37.00 call for additional net option credit of $426.00. This is the poorest performer in my current portfolio and I’m at a breakeven due to option-selling with exit strategy execution.
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