What happens when a covered call writing trade progresses much better than anticipated? This article will analyze a series of trades executed by William (thanks for sharing) with NUE as he utilized the BCI mid-contract unwind exit strategy. What rules and guidelines should we use to determine if closing both legs of our covered call trades mid-contract makes financial sense and will allow us to achieve even higher overall returns?
William’s NUE trades
- 7/25/2021: Buy 100 x NUE at $96.87
- 7/25/2021: STO the 8/20/2021 $95.00 call at $4.90
- 8/6/2021: BTC the 8/20/2021 $95.00 call at $9.70
- 8/6/2021: Sell 100 x NUE at $104.28
Let’s analyze whether instituting the mid-contract unwind exit strategy was a reasonable maneuver.
NUE: Initial trade structuring and calculations
NUE: Initial Trade Calculations
The 1-month time-value return (ROO) was 3.2% with 1.9% downside protection of that time-value profit.
NUE: Unwind trade entries using the Unwind Now tab of the Elite or Elite-Plus Calculators
NUE: Unwind Cost-To-Close Trade Entries
NUE: Unwind trade calculations using the Unwind Now tab of the Elite or Elite-Plus Calculators
NUE: Unwind Final Calculations
The time-value cost-to-close is 0.44% with 14 days remaining to contract expiration. We ask ourselves if we can generate at least 1% more than this time-value CTC in a new trade with a new underlying security or at least 1.44% This is reasonable given we are still half way through the contract. I will usually try to accomplish this using an in-the-money strike in the second position. If successful, we have generated more than a maximum return with the initial cash investment by instituting the mid-contract unwind exit strategy.
Discussion
When considering closing a covered call trade mid-contract after share price rises exponentially, we must first determine the time-value cost-to-close. If we can generate at least 1% greater than this CTC, the mid-contract unwind exit strategy makes sense.
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Hi Alan,
Quick question when you say on your weekly reports that you are favoring OTM strikes 2-to-1 over ITM strikes (as in the most recent report) – does that mean, as an example, if you were to sell 6 calls of MSFT that you would consider selling 4 OTM strikes and 2 ITM strikes. Or is the 2 to 1 ratio based on the number of different underlying stocks (e.g. selling 2 OTM calls on MSFT and 1 ITM call on AAPL).
Thanks.
Roger
Roger,
I base that statement on total contracts sold in a contract month. Let’s say I sold 90 January contracts. Of those, 60 would be OTM and 30 ITM. I base my ratio decisions on overall market assessment, chart technicals and my personal risk-tolerance.
If I sold 6 contracts of MSFT and I was bullish on MSFT, I would sell 4, 5 or 6 contracts OTM. Another stock with mixed technicals would result in the sale of 4, 5 or 6 contracts ITM. Currently, my total portfolio ratio is 2-to-1 in favor of OTM strikes for the January contracts.
Alan
Hi Roger,
Another way you could employ Alan’s OTM/ITM approach is to “Ladder” your strikes. This term comes from our fixed-income friends. Using the Microsoft 6 call example, you could sell 4 MSFT contracts OTM and 2 contracts ITM. This way you can both have potential upside appreciation, while at the same time, have some downside protection. Personally, I tend to do this on a regular basis.
I hope that this gives you another perspective on how you can put Alan’s market views into action.
Best,
Barry
Alan,
Reading book..Getting it…it all makes sense. Many pieces to master.
You said you sell calls simultaneously at different strike prices during the option period…sort of a boundary it seems..
I was looking at the QQQ for next week to paper trade with strikes above and below…
Where is the flaw in selling ITM and OTM calls at the same time during the contract period?
Is this a strategy..it sort of appears so..
Please assist.
Thanks,
Russ
Russ,
There is no flaw, whatsoever, in mixing ITM and OTM strikes for the same security and same expiration date.
We first establish an initial time-value return goal range (1% – 3% for monthly ETFs is reasonable) and make sure our “moneyness” decisions, whether ITM or OTM, align with those goals.
Alan
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Dear Alan,
Page 273 Complete Encyclopedia: :”Time value of option must be close to zero”. What do you consider close to zero?
Russ
Russ,
The guideline is we look for the time-value cost-to-close to approach zero such that we can generate at least 1% more in a new trade with a different security by contract expiration.
We use the “Unwind Now” tab of the Elite or Elite-Plus Calculators to generate the time-value cost-to-close. As that stat approaches zero, it will become easier to meet that 1% threshold.
For example, if the tab shows a time-value cost-to-close of 0.35%, we review our watch list to see if we can generate at least 1.35% in a new trade by expiration Friday.
Alan
Dear Alan,
I get it, the time value of PRGO was reduced from 100 to 89 which resulted in a 0.2% ROO loss. BUCI was able to generate that and more before the contract cycle ended. Am I correct?
How did you arrive at a 1% minimum?
It appears that in one covered call you have the potential to generate money from stock appreciation, dividends and the premiums.
Is there something else or another stream of income that can be generated associated with covered calls that I am missing?
This is amazing, thank you many times over for your book and resources.
Regards,
Russ
Russ,
Your assessment is correct. The time-value cost-to-close is 0.2% and we seek a minimum of 1.2% in a new trade. The 1% or more is a subjective guideline that I created for my portfolios prior to publishing my books and video courses. Members can adjust that threshold based on trading goals and personal risk-tolerance.
Covered call writing trades have the ability to generate cash from premiums, share appreciation and dividends (when they apply). Additional cash may be generated via exit strategy executions.
Your due diligence is impressive… keep it up.
Alan
Got it. Oh yeah!!! Exit strategies as another source, right under my nose…
Alan,
Mid-contract unwinds (MCU) is one of the most important management tools of the BCI monthly CC methodology. It is a positive measure we can take if we are watching our positions closely each day.
While the 20/10 guideline is very important, it is nevertheless a mitigating action and turns many times into a losing trade.
The MCU is always a winner.
Roni
Roni,
It is important to have an exit strategy plan for all possible scenarios.
Not all trades will be winners but the ones that are, we want to maximize and the ones that turn out to be losers, we want to minimize.
Alan
Thank you, Alan
The BCI methodology is by far the best for us conservative retail investors/traders.
Roni
I’m still paper trading and looking for 2-3% roo. This week I saw an opportunity to make over half of that profit after only a couple of days on several positions. Even though the time value was more than the MCU strategy calls for, does it make sense to “lock in” that quick profit and then reinvest in other positions? It seemed to occur when the stock popped up significantly and I figured it may pull back just as quickly.
Bill,
When share price accelerates exponentially, leaving the sold strike deep in-the-money, we have maximized our returns as long as share price remains above the strike by expiration.
If we are early in the contract, the time-value component of the premium must be evaluated as it may still be significant. If we can generate at least 1% more than the time-value cost-to-close, initiating the mid-contract unwind exit strategy is a reasonable approach.
If not, we continue to monitor our original covered call trade, staying alert for other exit strategy opportunities.
Alan
Alan,
Thanks for the reply. I still have about 6 months of paper trading ahead of me before retirement. I have no doubt that the principles you have fine tuned will prove to be the best way forward. I’m running multiple paper portfolios to test my stock/strike/exit skills and really appreciate your patience with newby questions. Hope your holidays are going well. Thanks.
The dates are confusing. 24 days for the option; 11 days for the unwind; 30 days used in the calculator for annualized return.
Thanks
Joe,
From 7/25 through 8/20, there are calendar 27 days inclusive of start and finish days. That can be rounded to 1-month if we trade monthlys or divide the time-value by 27 and multiply by 365 to annualize precisely.
The 3.2% represents the initial structuring of the trade. We will not know the final trade results until all exit strategies are accounted for and expiration passes. Even then, if we still own the shares the results will be unrealized on the stock side of the trades.
Please send a screenshot of the calculator you are referring to.
Alan
Alan,
What do you consider to be the sweet spots for the short call expiration and the leaps call expiration-how far out in time?
Thanks,
Jeff
Jeff,
For the Poor Man’s Covered Call (PMCC):
Long LEAPS positions expire 1 -2 years out with a slight edge to 2 years because the cost-to-roll is less. See pages 153 – 154 of my book, “Covered Call Writing Alternative Strategies”
The short calls can be Weeklys (if available) or Monthlys. Weeklys may offer higher annualized returns and allow circumventing of earnings reports and ex-dividend dates while Monthlys will require less time and management.
My personal preference is to use Monthlys and integrate Weeklys (when available) in the contract months when there are earnings and/or ex-dividend dates upcoming.
Alan
Alan,
I apologize for another newby question as it seems you have already answered this one.
So, here is the question.
For liquidity you’ve mentioned we want to have 100 contracts of open interest and/or 30 cents or less bid/ask spread.
I am having trouble understanding which of these you intend as the common sense test.
1. 100 or more contracts of open interest with no more than a 30 cent bid ask spread.
2. 100 or more contracts of open interest regardless of bid/ask spread.
3. Under 100 contracts of open interest with no more than 30 cents bid/ask spread.
For my paper trading, I’ve been only looking at 100 contracts or more of open interest regardless of spread but have begun to wonder if that is really right.
Some of the stocks have pretty big spreads on the option bid/ask.
Thanks,
Bill
Bill,
Good question.
The main go-to guideline is 100 contracts of open interest. This is the one we use in our premium stock and ETF reports.
There are frequent scenarios when we have 60, 70, 80, 90 contracts of open interest but a bid-ask spread of $0.30 or less. In those situations, I would still consider the trade.
Alan
Hi Alan,
I have both vols of your encyclopedia and the exit strategies.pdf.
One of my Cov Calls was about 0.40 ITM and was assigned today very close to 4pm.
Between 4pm and 6pm, in extended hours, the stock surged nearly $4 and by 7pm settled back to near the 4pm price.
Was this a manipulation? The stock will open tomorrow as if nothing happened. I attached the day chart at close.
Thank you,
Joe
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Joe,
Unless there are extenuating tax issues, this is a big positive for you as you have maximized your trade based on its initial structuring and you have the cash back early to re-invest.
Now, market-makers have until 5:30 PM ET to let the Options Clearing Corporation know about contract exercise. If unexpected, good news comes out after 4 PM ET resulting in a projection of share price acceleration, exercise may occur. It is rare but possible.
In this case, there may have been a re-evaluation of the “good news” Check the news for this security and see what you come up with. Either way, (barring tax issues), you’re a winner!
Alan
Alan,
After you complete the screening/due diligence, do you only sell those calls that return greater than a 2% gain?
In your experience, are there always covered calls with 2% gain potential available on every monthly cycle due to premium alone? If this makes sense..
Regards,
Russ
Russ,
Yes, my target initial time-value return goal range is 2% – 4% for my initial trade structuring and those opportunities (with rare exceptions) have been available over the past 2+ decades.
The target range is based on my personal risk-tolerance which may or may not align with that of other investors (1% -2% in my mother’s portfolio, for example).
BCI provides 3 reports (stock, ETF and Blue Chip) to our premium members. These are the only resources I use.
Alan
Dear Alan,
In you book CSP, it is mentioned that for the exit strategy “3% guideline” you can automatize with your online broker when the share price declines more that the 3% of the Put strike. Do you have the name of the “order”, like a conditional order?. I am trying to configurate in my paper account of Interactive Brokers but still not being able to find it.
Best regards
Alex,
With calls, it’s easier to partially automate the process using the 20%/10% guidelines because those are based on the contracts we sold.
For puts, we are basing the 3% guideline on a stock we do not own. I check my positions at least once or twice a day.
Ask your broker if they provide a service where email or text notification can be sent when share price reaches that 3% threshold.
You can also ask about “OTO” orders or one-triggers-other. If share price reaches $xxx, then BTC put option at best available price.
IA will let you know which of their services best align with your goals.
Alan
Hi Alan. I will check with my broker if they have OTO orders. Thanks so much as always.
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Hello Alan, are there any special consideration for stocks/ETFs with very low option interest?
I am also wondering if you would consider making a guide or devoting time to protective puts and collars. As simple as it is to buy a put or set up a collar, I’ve been confounded multiple times when incorporating them into trades – bad strike choice, bad timing, wasted money, etc. As always, thanks for your teachings!
Robert,
Our guidelines for option liquidity are 100 contracts of open interest and/or bid-ask spread of $0.30 or less. Our premium reports use 100 contracts of open interest on the option side and a minimum average trading volume of 250,00 shares/day on the stock or ETF side.
Here are links to the BCI resources for collar trades:
https://thebluecollarinvestor.com/minimembership/covered-call-writing-alernative-strategies/
https://thebluecollarinvestor.com/minimembership/video-the-collar-strategy/
https://thebluecollarinvestor.com/minimembership/collar-calculator/
Alan
Alan,
I hope this holiday season is going well for you and your family.
I know you have been selling options for a long time. Have you ever done a rate of return comparison between exclusively selling puts vs writing covered calls ( using your 2-4% guidelines).
I understand that because selling a put is a one legged trade it is much simpler than writing a covered call. Also when you write an out of the money call you give yourself a second chance at making money, however that second chance comes with a risk because you have to first purchase the stock at the current market price.
The reason I’m asking is because I am trying to determine my course of action for this upcoming year. Should I continue primarily selling puts? Or should I primarily sell covered calls ?
I know your answer will probably have something to do with risk tolerance. I clearly have a higher risk tolerance because I’m comfortable using margin. I’d really like to see this turn into a self sustaining fortune for me and my family.
Based on your experience, would writing more out of the money calls help me too.
Thank you,
Antonio
Antonio,
I use both calls and puts in my option-selling portfolios but favor covered call writing in normal to bull market environments because of our ability to generate the 2 incomes streams per-trade you alluded to in your question. Dividends and exit strategies can be 2 more sources of revenues. I have also developed 2 ultra-low-risk strategies for selling calls and puts.
Share price decline is our enemy and, therefore, our risk for both calls and puts. Even though we don’t own shares when we sell cash-secured puts, we are at risk of owning those shares and a higher price than the put strike, our contract obligation.
You may want to consider using both strategies in your portfolios as I do and dedicate each portfolio to a specific strategy.
You may also consider the PCP (put-call-put or wheel strategy) where we combine both strategies into 1 multi-tiered option-selling strategy. Here, we enter our covered call trades by first selling OTM puts:
https://www.thebluecollarinvestor.com/using-put-selling-to-enter-a-covered-call-trade-at-a-discount/
Bottom line: Yes, selling OTM covered calls in normal to bull markets will enhance our portfolio returns.
Alan
Hi Alan,
Happy New Year. I noticed in all your literature pertaining both to covered calls and Secured Puts that the strike price you use in almost all examples are only a dollar or two from the stock price.
Is this strike price selection just for demonstration purposes? or do you typically only do strike prices within a couple of dollars. I mean you could go 5 or 6 dollars.
Please explain the logic or the rationale.
Thanks,
Tom
Tom,
The strike price we select is based on our initial time-value return goal range. If our goal is for a 2% – 4% initial monthly return, the strikes will be relatively close to current market value.
I have published several articles and books that include other strategies where we seek lower returns and go deeper out-of-the-money or in-the-money. Portfolio overwriting is one such strategy.
Here is a link to an article I published where the stock price was $170.09 and the deep OTM $150.00 cash-secured put was sold:
https://www.thebluecollarinvestor.com/using-delta-to-create-low-risk-high-return-put-selling-trades-a-real-life-example-with-etsy-inc-nasdaq-etsy/
One of the huge benefits of these strategies is that they can be crafted to our goals and personal risk-tolerances.
Happy New Year,
Alan