Covered call writing or selling cash-secured puts… which is the best strategy? Well, they both offer great opportunities to generate cash-flow in a low-risk manner. I favor the former in normal to bull market environments and the latter in bear and volatile markets. On June 24, 2019, PCTY passed our rigorous screening requirements to earn its way onto our premium watch list. Let’s look at the initial and final trade results for each strategy for the July 2019 contracts.
Price chart for PCTY (Yellow field shows July contract)
PCTY Price Chart for the July 2019 Option Contracts
PCTY was trading at $97.01 at the start of the contract and closed at $104.84 at contract expiration resulting in successful outcomes for both strategies.
Covered call writing with PCTY
PCTY: Covered Call Writing Calculations with the Ellman Calculator
Between option premium and share appreciation up to the $100.00 strike, the trade resulted in a 1-month realized profit of 6.3%. Had share price declined, the breakeven would have been $93.91.
Selling cash-secured puts with PCTY
PCTY: Put-Selling Calculations with the BCI Put Calculator
The option premium generated a 2.21% 1-month realized return. Had share price declined, the breakeven would have been $92.95.
Summary
Both covered call writing and selling cash-secured puts are outstanding approaches to generating cash-flow in a low-risk manner. In favorable market conditions, we benefit from writing out-of-the-money calls where we can realize share appreciation up to the out-of-the-money strike in addition to option premium. In declining markets, out-of-the-money put-selling will generally result in a lower breakeven, affording us greater downside protection. If the put is exercised, we can continue the defensive investment process by writing in-the-money covered calls.
Market update
I am in 50% cash with better-performing stocks as well as Inverse ETFs populating the remainder of my portfolios. I hit several doubles this week always looking to find silver linings in these challenging times. With a strong jobs report, low interest rates (with more reductions to come) and favorable earnings, I am solidly bullish longer-term once we pass the coronavirus issues.
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1. Tuesday March 10, 2020 Long Island Stock Traders Meetup Group
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Covered Call Writing Blue-Chip Stocks to Create a Free Portfolio of Large Tech Companies
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Alan,
So your advice is to don’t do anything until vaccine is on the market?
Thanks,
Keith
Keith,
This will vary from investor-to-investor. I am currently 50% in cash. My positions include better performing stocks as well as inverse ETFs (see page 6 of our premium member ETF reports).
More experienced investors who have experienced highly-volatile market conditions in the past and who can eliminate emotion from investment decisions, may decide to be partially or totally invested.
For many retail investors, staying in cash and paper-trading through these challenging conditions makes good sense.
Market conditions are still in place for continuation of this long-term bull market once a vaccine is available. Look for another likely Fed rate cut later this month which should assist with market performance.
Alan
Alan,
You stated above:
“With a strong jobs report, low interest rates (with more tightening to come) and favorable earnings, I am solidly bullish longer-term once we pass the coronavirus issues”.
Did you mean more reducing to come or did you really mean “more tightening to come”?
All indicators seem to indicate more reduction of interest rates to come. Not that I agree rates should be reduced further. I actually think the “emergency 50 basis point reduction was a mistake. It, in my opinion, made people more scared. For example,”The Fed thinks things are really bad and had to do an emergency reduction”.
Hoyt
Hoyt,
Yes, I meant another rate cut as I responded to Keith. I changed it in the body of the blog.
Thanks for the catch.
Alan
Alan,
You did. My bad.
Hold on tight today. Your inverse ETFs should perform well today.
I went to 30% cash in the fall. Reduced my core holdings to four equities, four ETFs and three LEAPs calls position. Of course if I had it to do over I would have gone to 100% cash.
I get the concepts of inverse ETFs but have never utilized them and never really looked under the hood to fully understand them. Of all the rules I have broken over the years the one I have not broken is that I don’t invest/trade in securities that I do not fully understand.
It has always been my position that there are instruments available in all circumstances that I do understand. That said, based on what I do know about inverse ETFs I believe they would be a good way to respond to our current market for the short term.
Best wishes and good luck.
Hoyt
Premium Members,
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 03/06/20.
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Premium Members,
We’re having a slight problem updating the first page of the 03/06/20 Weekly Report. Although the top line of the “Market Overview” page, the first page of the report, says 02/28/20, the report is the latest report just uploaded. All of the other title page headers show the correct date.
Again, the uploaded report the most current report. Sorry for the minor confusion.
Best,
Barry
Hi Alan,
Thanks for your comments from last week. There is a larger set of issues too.
I am a long term holder of Exxon. While the value has gone down, I have done nothing with it. From time to time I would look at the options. But with an implied volatility of 10-15%, I just didn’t see it as worth using for options trading. Now the IV is up to 80%. The potential returns are significant. However, the question is: How long can the IV be expected to stay in a worthwhile range? A month? 6 months? A year?
I call this my IBM moment, thinking back to the 1980s when IBM was at $55/share.
Frankly, I believe that over the next several years, AT BEST, oil will go above $60/bbl maybe 10% of the time. The terrorist premium is gone. The major oil companies know they have to make significant adjustments. But Exxon keeps making these missteps, the latest being getting out of Marcellus in PA, and I think they were cutting back on assets in New Mexico. Personally, I see these as left over legacies from Rex Tillerson, who is turning out to be one the companies worse chairmen in their history. The new guy might be making better decisions. I am just not sure.
Anyway, the risk profile I see for trading options on Exxon puts me in a quandry. Stock price recovery probably weak, and as the economy recovers the IV will return to historical levels. I am sure there is a common sense way to look at this. I just haven’t found it yet.
All the best,
Cort
Cort,
XOM, along with most other oil companies are highly volatile due to the dramatic price declines. IV is generally inversely related to price movement. The futures are implying XOM opening down another 10% – 15% today.
As it relates to option-selling, we must first decide if we intend to hold onto the stock. If the answer is yes and we want to mitigate losses, we can sell OTM calls that meet our initial time-value return goal range. These prices will be set after the market opens because the price decline at open appears to be dramatic.
Right now fear has taken hold of the market and so establishing a bottom is critical. It appears today that the bottom from 2/28 will be tested or perhaps reset to a lower level. Once a bottom is established, re-tested and selling volume dries out, we will have a bottom to work with and then there will be more clarity on how and when to move forward.
In the interim, I am in 50% cash while holding a few better-performing underlyings along with inverse ETFs.
One of the most difficult skills for retail investors is to take emotion out of the equation in challenging market environments like we have now. Doing so will benefit our portfolios long-term.
Let’s keep an eye out for an established bottom.
Alan
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Alan and the BCI team
Hi Alan, how does inverse ETFs work? it is working for you these few days? any video you recommend me to watch and get familiar with inverse ETFs?
Thanks,
Keith
Keith,
I have archived on this site and in the past few premium reports that about 10 days ago, I moved to 50% cash and retained a few better-performing stocks with a heavier presence of inverse-ETFs taken from page 6 of our premium ETF Reports. These are securities that appreciate in value when market benchmarks depreciate in value.
After I purchased these ETFs, I wrote OTM covered calls which are all now deep ITM as a results of the severe market decline. Once a bottom is established and selling volume dries out, it will be prudent to remove these securities from my portfolios.
Inverse ETFs should be considered only in extreme bear market environments or to hedge a portfolio. Here are links to articles I’ve published on this topic:
https://www.thebluecollarinvestor.com/covered-call-writing-and-inverse-etfs-generating-cash-in-extreme-bear-markets/
https://www.thebluecollarinvestor.com/inverse-exchange-traded-funds-versus-shorting-stocks/
Alan
Alan,
My question is a simple one. Are you concerned about going into Friday night, all day Saturday, all day Sunday and Monday morning… the 2 day weekend with say 50% in cash (your announced cash position last Wednesday in the Wednesday BCI report) in our very volatile market. Over the weekend, the markets could dramatically shoot up based on some unforeseen event(s) or announcements and the Monday morning futures could point to a then missed 10% to 15% increased market open.
Your thoughts, please. I’m not looking for financial advise, but rather thoughts and ideas.
Thank you Alan,
Tay
Tay,
I am not prepared to increase my positions today because of a possible bump up in market value. I am looking for a market bottom that has been re-tested (possibly multiple times) and with trading volume on down days drying out. At that point, I will be prepared to re-invest the cash I took out of the market. In the interim, there are a handful of securities, including inverse ETFs that have been working well in this environment.
Alan
Alan,
I wanted to ask what do you plan to do with ‘better performing’ stocks you still have in your portfolio? I assume you already bought the options back following the 20/10% rule. Are you rolling them down or waiting for market to bottom?
Thanks,
Sunny
Sunny,
Since we are in the latter half of the March contracts, when the 10% BTC limit order is met, I will roll down preferably to an OTM strike. This will both generate additional time-value premium and allow for share appreciation.
If the underlying is under-performing the overall market (tough to do these days!), I may sell the stock. Generally, to answer your inquiry, yes, roll-down.
Alan
Alan,
I have placed my first cash secured puts order on gild 62.50 strike price for 4/17 – 3 contracts for today.
Thoughts…
Thanks
Murali
Murali,
This is a challenging market environment to make initial option-selling trades. That said, using deep OTM cash-secured puts is a safer way to do so.
GILD has been one of the better-performers of late but lost about 5% of its value yesterday. It looks like it may recover that today. The implied volatility of its options is high so the premium you received was most likely substantial but so is the risk to the downside so be prepared with our exit strategy arsenal.
The market reaction to the coronavirus crisis will play a major role in the final outcome of our trades.
Alan
Hi Alan:
Per summary:
“If the put is exercised, we can continue the defensive investment process by writing in-the-money covered calls”
Wouldn’t you write the call at the same strike price you were assigned? Or is it better to write it at a higher strike price?
Marie,
If the shares are “put” to us, our cost-basis is the put strike minus the put premium. Let’s say we sold a $70.00 put strike for $2.00… our cost-basis is $68.00.
The call strike can be ITM or OTM depending on our market assessment and chart technicals. Either way, the initial time-value return must fall within our stated goal range.
Alan