Accurately calculating our covered call writing returns at the end of each contract cycle can be uncomplicated in some situations and more challenging in others. If we buy a stock at $48.00 and sell the $50.00 call at $1.50 and we allow exercise of an ITM strike (shares sold at $50.00 for a $2.00 per-share profit), we have a net gain of $3.50 per-share ($1.50 + $2.00). This represents a realized return of 7.29% ($3.50/$48.00). Easy.
This article will analyze a scenario where the option expires out-of-the-money and exercise does not occur. I will use a real-life example with United Therapeutics Corp. (Nasdaq: UTHR) taken from Chapter 4 of my book, The Blue Collar Investor’s Guide to: Exit Strategies for Covered Call Writing and Selling Cash-Secured Puts.
UTHR covered call trades
- 2/22/2021: Buy 100 x UTHR at $155.90
- 2/22/2021: STO 1 x 3/21/2021 $160.00 (OTM) call at $3.50
- 3/21/2021: UTHR trading at $158.25 (leaving the $160.00 strike OTM at expiration)
- 3/21/2021: The $160.00 covered call option expires worthless, and shares are retained at $158.25
Initial trade entries and calculations with the BCI Trade Management Calculator
The spreadsheet shows an initial option time-value return of 2.25% (red arrow), 29.27% annualized based on a 28-day trade, with an additional 2.63% of upside potential if share price rises to or beyond the $160.00 strike.
Final calculations with the BCI Trade Management Calculator
Note the following:
- The final realized options return is 2.25% (red arrow), the same as the initial option returns
- The final (as of contract expiration) unrealized stock return is 1.51% (green arrow), less than the original maximum upside potential of 2.63% had UTHR appreciated to or beyond the $160.00 strike)
- This nets a final total (realized + unrealized) return of $585.00 per-contract or 3.75% for the 28-day trade (brown cells)
When calculating our final covered call writing returns at the end of a contract cycle and the underlying shares are retained, there will be a combination of realized option returns + unrealized stock returns (gain or loss). In this example, if UTHR closed below the original purchase price of $155.90, there would be an unrealized loss on the stock side and a net gain or loss depending on the amount of share decline.
COMING SOON: A streamlined approach to covered call writing: New Book & 2 New Spreadsheets
Alan’s recent interview on Money.net
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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 have really enjoyed your books and system. As of the close of the market yesterday, I had collected $5,300 in premium since joining. I rolled forward one time and used an NTM call to dispose of some shares that I was planning to sell. Collecting an additional $600 was a nice way to exit the position. I am looking forward to continuing to learn and apply your system. Thanks so much for the education you are providing.
Happy holidays to you and your family!
To request a private webinar for your investment club, hosted by Alan & Barry: [email protected]
1.Long Island Stock Traders Meetup Group
Analyzing a 1-Month Covered Call Writing Portfolio from Start to Finish
A real-life example with a $100k ETF Select Sector SPDR portfolio
Thursday February 16,2023
7:30 PM ET- 9 PM ET
Covered call writing is a low-risk option-selling strategy that generates weekly or
monthly cash flow. This presentation will demonstrate how to implement this
strategy using a database of only 11 exchange-traded funds for a 1-month option
contract cycle. These are real-life trades taken directly from one of Dr. Ellman’s
portfolios with screenshots verifying each trade. A final monthly contract result
compared to the performance of the S&P 500 will be calculated.
Topics included in this webinar:
What are the Select Sector SPDRs?
How to establish a covered call writing portfolio
What is the role of diversification?
What is the role of cash allocation?
Calculating initial returns
Analyzing each trade in the monthly contract
Go to www.meetup.com/listmg
Click on join to become a member (Free membership)
Then click on RSVP (meeting is free) to obtain the ZOOM link.
2.Mad Hedge Investor’s Summit
Wednesday March 15th
11 AM ET – 12 PM ET
Portfolio Overwriting: Covered Call Writing Our Buy-And-Hold Stocks
Increasing profits and avoiding tax issues
Our buy-and-hold portfolios in non-sheltered accounts are generating 8% – 10% per year. Can we increase these yields by selling stock options while, at the same time, dramatically decreasing the probability of our shares being sold to avoid potential tax implications? The answer is a resounding “yes”. Portfolio Overwriting is a strategy that can benefit millions of investors seeking to enhance portfolio returns using a low-risk covered call writing-like strategy.
Registration link to follow.
3.NYC & Long Island Stock Traders Investment Groups
Thursday March 16th, 2023
7:30 – 9 PM ET
Topic related to selling cash-secured puts.
Details to follow.
Market tone data is now located on page 1 of our premium member stock reports and page 1 of our mid-week ETF reports.
I need a ruling from the man:
I’ll explain the particulars in a second, but the question is:
If I was about to get Called Away on an option/stock that is far below the Basis, is it better to get called away and repurchase at the new lower cost or Buy To Close the Option and not get Called Away.
The details….I have 100 shares of Tesla with a Basis of $270. I accidentally violated the Prime Directive and sold a Call on my Tesla stock last week with a Earnings Call (25 Jan) in between the two dates. The Option was a 160 Call that expired Friday (27 Jan).
This is stock I plan on keeping for a while and I think it will go higher. With that in mind, do I let the Option get exercised at 160 and purchase the stock again….with the much lower Basis of $160?
Or do I BTC?
Most people would think this is an easy answer, but here’s why I ask this question. If I get Called Away, I’m down $11,000, but I’m back in at 160. If the stock runs to 300 for example, I’m up a net of $3000 ($14k-11K). If I BTC and preserve my stock at $270, then I am still only up $3000 if the stock goes to $300 (300-270).
So either way I am still up the same $3000, except by getting Called Away, I would also have a $11,000 loss to use against any Capital Gains.
What I ended up doing is BTC, but I was wondering what you thought Alan.
A few points you should find useful:
1. When we allow assignment of shares we seek to retain for the long-term, we are exposing ourselves to weekend risk. If share price moves much higher by Monday, we lose and vice-versa.
2. The strategy being used is “portfolio overwriting” where a key component is share retention. In these trades, we accept lower returns (than traditional covered call writing) in exchange for a high probability that the option will not be subject to exercise. We use deep OTM calls based on at least one of these factors: Delta, implied volatility or lower initial time-value return goal range (6% annualized, as an example). See this article as 1 example:
3. Ask your tax advisor about the “Wash Rule” and if there is any tax advantage to allowing exercise and repurchasing on Monday.
Thank you Alan,
Good info and I forgot all about the Wash Rule.
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 01/27/23.
We were successful in implementing our system backup and recovery procedures to address our earlier systems issues.
Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them on The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:
Reminder: Premium members are grandfathered into your current rate and will never see a rate increase as long as the membership remains active.
Barry and The Blue Collar Investor Team
Good Morning Alan!
First let me express how grateful I am for your material. It is the first time in my trading career that I can finally see the ‘whole picture’ from start to finish.
My question is about trade entries using TMC –
Based on your recommendations, I now use a new sheet per month. Thank you! My question is – do I save according to trade entry date or trade exp. date?
Also, how do I handle a single entry trade that spans multiple months? Do I start the next month using cost basis?
Thank you for your generous comments.
I use the expiration date in my saved TMC spreadsheets. As an example, for the February 2023 monthly expirations, I name the file: TMC_2-2023 or TMC_2-17-2023. When the contract has expired, the spreadsheet goes into a TMC folder on my device.
If a retained security is used in the next contract cycle, we use the lower of the current market value or the previous strike, if rolling the option, as the cost or value of the security in the next spreadsheet. The previous change in share value has already been accounted for in the, now expiring, contract spreadsheet.
The Weekly Report has been revised and uploaded to the Premium member website. The ER date for WCC has been revised. The new ER date is 02/14/23 vs. the original date of 02/21/23. The updated Weekly Report is available on the Premium member site. look for the report dated 01/27/23_RevA.
Watch list and stocks selection are they same for both CC and CSP.
Technical analysis are they not different for CC we use overbought and
for CSP oversold condition in chart.
Please clarify and oblige.
The screening process is precisely the same for calls and puts.
We win if shares price moves up, stays the same or moves down but not below the breakeven price point.
We only lose if share price moves below breakeven, so we screen securities that will have the best chance of not declining in price. This includes fundamental and technical analysis in addition to common-sense screens like minimum trading volume and avoiding earnings reports.
Regarding technical analysis, the 4 parameters used in our BCI methodology screen for trend. momentum and volume. These indicators will form a mosaic that will allow us to make a bullish, neutral or bearish assessment from a technical perspective.
Bottom line: There is absolutely no difference in the screening process for calls and puts.
This week’s 5-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site. The report also lists Top-performing ETFs with Weekly options, mid-week market tone as well as the implied volatility of all eligible candidates.
New members check out our ongoing and never-ending training videos (“Ask Alan” and Blue Hour webinars). We add at least one new video each month. Only premium members have access to the entire library of these training tools.
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Alan and the BCI team
Hello again Alan.
I hope all is well. As always I value your opinion.
I seem to be having a good problem. I generally have about 20 positions every month a few of the stocks rise more than 5% within first 2 weeks and are significantly in the money. My calculations at that time May tell me I can make about 2% -3% if I buy to close and sell stock.
If I hold out 2 more weeks to expiration I may only make another 1%. So I am in dilemma whether to completely close positions after the 10 days – 2 weeks and buy another stock and sell options on new 4 week period.
This is equivalent to the mid cycle move you describe where stock rises. But in my situations there is still some time value left on the option on the buy back. What do you think?
When we set up a covered call trade, we sell options that will meet our pre-defined initial time-value return goal range. If we sell OTM calls, we aspire to achieve a 2nd income stream of share appreciation from current market value up to (or beyond) the OTM call strike. We are also agreeing to sell our shares at the strike price we established when crafting the trade.
When share price moves up exponentially, leaving the strike deep in-the-money (ITM), we are achieving a maximum return (exit strategies aside) at that point in time. In addition, we have a huge amount of downside protection of that max return from current market value down to the (now) ITM strike. I would consider replacing “good problem” with “best case scenario.”
Now, you are 100% correct that the exit strategy that may apply in this scenario is the BCI “mid-contract unwind (MCU)” exit strategy, where both legs of the trade are closed, and a new trade is initiated. My preference, when using MCU, is to stay within the same contract expiration cycle.
Here is the BCI guideline as when to initiate MCU:
If we can generate at least 1% more than the time-value cost-to-close with a new position, then MCU should be strongly considered. As an example, if the time-value cost-to-close is 0.75%, if we can generate 1.75% or more with the remaining time to expiration (same expiration as original trade) in a new position, the MCU is appropriate.
As usual I appreciate your response.
Only 1 question:
The only scenario, altho unlikely, that needs to be considered as well is if you do not take action and hold to expiration there is unlikely but possible consequence of the stock price taking large hit and ending less than strike. Should this be considered in your actions?
If a decision is made to take no action and not institute MCU, we then continue to monitor the trades moving forward with our 20%/10% BTC limit orders always in place.
If share price continues to rise, causing the time-value component of the premium to move lower, MCU may become appropriate.
If share value declines, triggering the 20%/10% BTC limit orders, we can the take the appropriate exit strategy actions.
We are always in position management mode after entering our trades.