Covered call writing or put-selling? In-the-money or out-of-the-money strikes? When we view an options chain there are some basic principles we must factor into our final covered call writing or put-selling decisions. First, which of these two strategies is most appropriate? Unfortunately, there is no one answer that is right for every investor. I prefer covered call writing but that is a product of the success I’ve enjoyed using that strategy over the past two decades. Others, favor selling cash-secured puts. When I do use put-selling, it is because I have a bearish market outlook and slightly favor put-selling in those environments. Both are great strategies that can be tailored to meet our overall market assessment and personal risk tolerances.
Once a strategy is selected, we must next choose a strike price. In both strategies, this choice is based on the following factors:
- Overall market assessment
- Chart technicals
- Personal risk tolerance
In other words, are we bullish or bearish about the market in general and the stock in particular? In a future article I will discuss a bear market scenario. In today’s blog I will use a bull market situation and highlight the options chain for Michael Kors Holdings Ltd (NYSE: KORS). In this example, I will show potential trade selections for both strategies. Finally, I will show the calculations for these trades which will demonstrate to us if these results meet our monthly goals. Please note that we are showing 6-week returns, so to annualize we multiply by 8.5.
NNote:Note: Article taken from my new book, Selling Cash-Secured Puts.
Options chain for KORS Holdings Ltd. as of May, 4, 2014:
In the pink-highlighted row I show strikes we may consider in bear markets. In this article, we will focus in on the yellow -highlighted rows which are appropriate for bull market environments.
Bull market trade and calculations for covered call writing
We favor out-of-the-money strikes which will generate time value returns that meet our goals along with upside potential from share appreciation moving from the purchase price up to the strike price. The deeper out-of-the-money we go, the greater our upside potential but the lower the initial time value profit. With KORS trading @ $93.90, we will view the $97.50 OTM strike:
- Call premium = $3.20
- Upside potential from $93.90 to $97.50 is $3.60
- Time value of the premium = $3.60 (ATM and OTM calls are all time value) (should read $3.20 as per Jeff’s comment below…thanks Jeff)
- Initial profit = $320/$9390 per contract = 3.4%
- Annualized return = 29%
- Upside potential = $3.60/$93.90 = 3.8%
- Maximum 6-week return = 3.4% + 3.8% = 7.2% or 61% annualized
- Breakeven = $93.90 – $3.20 = $90.70
Bull market trade and calculations for selling cash-secured puts
We favor slightly out-of-the-money strikes as well as at-the-money and slightly in-the-money strikes which will generate higher initial returns than deeper out-of-the-money strikes. We do this to take advantage of the bull market environment to generate the highest possible returns while still having capital preservation in mind. With KORS trading @ $93.90, we will view the $95.00 slightly ITM strike:
• Put premium = $5.30
• Initial profit = $530/$9500 per contract = 5.6%
• Annualized return = 47.4%
• Breakeven = $95.00 – $5.30 = $89.70
Note: This information was taken from my new book: Selling Cash-Secured Puts. For more information on both options strategies, visit our Blue Collar store.
By incorporating overall market assessment, chart technicals, personal risk tolerance and calculation results we can make informed, non-emotional decisions as to which strategy and strike price will be most appropriate for our portfolios.
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Our economy continues to outpace those of most other developed countries in the global economy:
- According to the Commerce Department, the US gross domestic product (GDP) expanded to 3.9% in the 3rd quarter on an annualized basis. This is an increase from the 3.5% estimate reported a month ago
- After a weather-impacted GDP contraction in the 1st quarter, the next 6 months saw the GDP grow at a 4.25% rate, the best since the 2nd half of 2003
- The Fed is expected to keep monetary policy where it is until sustainability is confirmed
- Personal spending rose by 0.2% in October and the September figure was revised upward from 0.0% to 0.2%
- New home sales in October increased to an annualized 458,000. the 3rd consecutive monthly increase
- New home sales were up 1.8% year-over-year
- Durable goods orders rose by 0.4% in October, much better than expected
- The Conference Board’s Index of Consumer Confidence fell to 88.7 in November after reaching a 7-year high in October
- Initial jobless claims for the week ending November 22nd, came in at 313,000, more than the 288,000 anticipated
For the shortened week, the S&P 500 rose by 0.2%, for a year-to-date return of 14%, including dividends.
IBD: Confirmed uptrend
GMI:6/6- Buy signal since market close of October 27, 2014
BCI: Moderately bullish favoring out-of-the-money strikes 2-to-1
Wishing you the best in investing,
Alan ([email protected])