An accepted myth is that covered call writing and selling cash-secured puts are precisely the same strategy. The reason this statement is generally accepted by many investors is that they have the same risk-reward profiles or profit and loss graphs:
Profit and Loss Graphs
In this article, other similarities will be discussed as well as some distinct differences between the two strategies that will debunk the myth that they are precisely the same strategy.
More similarities
Both leverage underlying securities to generate cash flow
The screening process and watch lists are the same
Both require the same skill set
- Stock selection
- Option selection
- Position management
Differences
Dividends
Covered call writers (share owners) collect corporate dividends, put-sellers do not. However, due to put-call parity, put-sellers tend to generate a higher premium when an ex-dividend date comes up prior to contract expiration.
Maximum profit
Covered call writers can capture both option premium plus share appreciation if out-of-the-money strikes are sold. Put-sellers capture option premium only.
Initial step
Covered call writers buy the underlying security in 100 share increments. Put-sellers place an appropriate amount of cash into the brokerage account which then “secures” that put.
Market outlook
Covered call writing works best in slightly bearish to bullish market conditions. Put-selling is best suited for slightly bearish to neutral market conditions.
Use in Self-directed IRA accounts
Covered call writing is universally allowed in IRAs while put-selling is allowed only by certain brokers.
Level of trading approval
Most brokerages require a higher level of trading approval for put-selling because they feel that it is not as intuitive as is covered call writing.
Early assignment
This is not an issue for covered call writing (assuming no tax issues) because we know our cost basis. For a declining stock, early assignment of a short put may result in a greater loss since notification may not come until the next trading day.
Cost to close when price declines
It will be much less expensive to close a short call than a short put. This is because call value declines with a decrease in share price while put premium increases with a decline in stock price. This will require us to set aside a greater cash reserve to buy back a short put on a declining security.
Advantages of put-selling
In bear and volatile markets, put-selling can be used before buying a stock. Using out-of-the-money puts will allow us to buy a stock “at a discount” before writing an in-the-money call. This creates an additional layer of downside protection in challenging market conditions. In this same regard, put-selling can be used in lieu of setting limit orders when there is a desire to buy a stock but at a lower price than current market value.
Discussion
Covered call writing and selling cash-secured puts have the same profit and loss graph profiles but also differ in many ways. By understanding the similarities and differences between these two option-selling strategies, each investor can make the most appropriate decisions as to when and how to implement these strategies.
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#1 best-selling book on covered call writing or add DVD Program
#1 best-selling book on selling cash-secured puts- Put-Selling DVD Program also available (scroll down to bottom left)
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Holiday discount last week– Use promo code HOLIDAY10
Login here and use promo code holiday10 to get a 10% discount on our store items through December 15th for holiday delivery.
Options Industry Council’s webinar summit:
To hear a replay of my December 1st panel discussion event hosted by the the Options Industry Council:
http://event.on24.com/wcc/r/1275040/6E8D5F7A3A547F1E3EB77C7AAA813C76
They will ask you to register first…it’s free.
I am one of 3 presenters. I go on:
35:20 – 58:00 and
69:07 – 69:55
Presentation slides correspond to the audio
Hope you enjoy it.
Upcoming live events
1- Blue Hour webinar #4 (late January/early February)
Date and time to be announced
“The Poor Man’s Covered Call”
2- February 27, 2017
Marriott Marquis Hotel, NYC
1:30 PM ET
Exhibit hall Booth 208 (February 26th – 28th) … come say hi to the BCI team
Market tone
Global stocks boasted solid gains this week, as major US indices set new records and European stocks enjoyed their best week since February. The S&P 500 Index gained about 4.05% for the month, setting a new all-time high. Oil prices dipped slightly this week, with West Texas Intermediate crude falling 58 cents a barrel to $51.10. This week’s reports and international news of importance:
- Global stocks continued to post strong gains this week as investors moved out of defensive asset classes, taking on more risk
- The strongest segments of the US market since the election have been materials, industrials, energy, financials and technology
- High-yield bond sector spreads remained compressed, with most sectors sitting at 52-week lows, indicating that investors are still seeking yield opportunities
- US investment-grade bond spreads narrowed as well, but slightly
- Yields on municipal bonds also fell this week, indicating a reversal of a recent selloff in the asset class
- The European Central Bank announced that it would extend its quantitative easing program until December 2017, although it reduced its monthly purchases
- The eurozone economy has improved in recent months, although two of this week’s data releases fell short of expectations. UK manufacturing output unexpectedly fell 0.9% in October, and German industrial production also disappointed
- Italian voters rejected a referendum on constitutional reform early last week, prompting Prime Minister Matteo Renzi to resign. The result continues the anti-establishment trend in the United States and Europe
- Austrian voters elected pro-European candidate Alexander Van der Bellen as president this week, opposing the anti-establishment trend in the European Union
- China’s trade data surprised analysts to the upside this week as imports and exports both increased sharply in November. Exports rose 0.1 % year over year, reversing a 7.3% decline recorded in October, while imports grew 6.7%, the fastest pace since 2014
THE WEEK AHEAD
- China’s industrial production and retail sales data are released on Monday, December 12th
- The Federal Open Market Committee meets on Tuesday and Wednesday, December 14th – 15th
- The eurozone’s industrial production figures are released on Wednesday, December 14th
- US business inventory, retail sales and industrial production data are released on Wednesday, December 14th
- US Consumer Price Index, NAHB housing market index and jobless claims data are released on Thursday, December 15th
For the week, the S&P 500 rose by 3.06% for a year-to-date return of +10.52%.
Summary
IBD: Market in confirmed uptrend
GMI: 6/6- Buy signal since market close of November 10, 2016
BCI: I am currently fully invested and have an equal number of in-the-money and out-of-the-money strikes. Despite the bullish nature of the market since the election, I would still like to see the economic and global policies of the incoming administration more precisely defined. As a result, I have rejected a more bullish approach for the December contracts and probably for the January contracts as well.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
The 6-month charts point to a bullish outlook. In the past six months, the S&P 500 was up 6% while the VIX also declined by 20%.
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Wishing you the best in investing,
Alan ([email protected])
I have found these two strategies work well in concert. More often then not I am better off entering positions through cash secured puts and then starting my call writing. Of course, that was pre-Trump: we all know the market only goes up now so I could be mistaken :)!
The market cut me a little slack yesterday morning. I was looking for a chance to get into RF “at a discount” after selecting it off our current list. I finally got a foot in the door selling the Jan $14 put for 42 cents for 3% initial return on the morning weakness. RF recovered through the day and finished at $14.60 so I now have an additional 4.3% downside protection and 7.3% total protection against my potential assigned cost basis of $13.58 if RF should hit the rocks in the next month and I do not exit.
I like the stock and would not mind owning it. Never sell a cash secured put unless you feel that way. Would I have been better off buying RF on the morning dip, letting it run up then selling an OTM call for January? Maybe.
But that is not the initial tactic I chose for this position. If RF keeps running, great! I will buy back the puts at a fraction of what I was paid, log a nice income trade and do it again. If the market takes an unexpected turn, always temporary, I am in a good stock at a better price than if I had bought it yesterday. And then I start my call writing campaign.
So my experience suggests using both put and call selling in your trading never second guessing one over the other. – Jay
I agree with the brokerages.
Cash secured puts feel less intuitive, and somehow more risky.
My risk tollerance today is very limited, and therefore I favor monthly covered call buy/writes.
The big difference to me is the fact that it feels easier to unwind a trade gone bad.
With covered calls I will be SELLING my shares at a reduced loss.
With cash secured puts I will be BUYING back a put option at a much higher price.
I know it is only psychological, but I can’t help myself.
Roni
Hey Roni,
My risk tolerance is low too. But risk, like beauty, is in the eye of the beholder :)!
In my trade above I will not own RF until it goes down over 7.3% and stays that way until Jan expiry. I warmed up to cash secured puts when I started thinking of them as getting paid to place limit orders I would have bought anyway. Sometimes I just buy. I use a blend.
Your points are well made: this game is about doing what best suits our risk tolerance and market view managing each trade as it develops. Have a great week! – Jay
Hi Jay,
please forgive me.
My post was NOT intended to comment your RF trade.
It was related to Alan’s article on Calls versus Puts.
Sorry it showed up right below your post, I should have waited for other posts before submitting mine.
Regarding your RF trade, I see it as a perfect example of smart trading and investing.
Further, on cash secured put selling and other more advanced trades, I hope that in the future I will be able to learn and use them.
Right now I had to reduce my trading time, because I had to return to work (2 days a week) :-(.
The severe recession in Brazil is giving us (my partners and me) a very hard time.
Have a nice week too 🙂 – Roni
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 12/09/16.
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:
http://www.youtube.com/user/BlueCollarInvestor
We have added additional indicator to the Weekly Premium Report this week. The new indicator is the “Put/Call Ratio”. The Put/Call Ratio (for the S&P 500) is an indicator of overall market sentiment and is the ratio of the volume of puts divided by the volume of calls. A ratio of 1 tends to indicate a bearish trend. You will find it in the “What The Broad Market Indicators Are Telling Us” in the Market Overview section of the Weekly Premium Member Report.
Best,
Barry and The Blue Collar Investor Team
Alan,
In your put book chapter about the PCP strategy you show out of the money puts. Do you ever use in the money or at the money with this strategy?
Thanks a lot.
Jordan
Jordan,
I generally use put-selling in bear and volatile market conditions in much the same way Jay described his RF trade above. I use out-of-the-money puts most of the time. Now, if one were using put-selling to buy a stock at a discount in lieu of a limit order, ATM and ITM puts are more appropriate because the chance of exercise is greater. So the “moneyness” of the put option selected, to a great extent, is contingent on our strategy goals.
Alan
Alan,
I don’t know if this is even possible! I had a stock (SNCR) drop approx $8.00 per share and wipe out a month and a half of my CC income due to M/A activity. Is there a way in the premium report to list even rumored M/A activity? This to me is an equal to or even higher risk than ER when we are making such short term trades.
Thanks so much and a very happy Holidays to you and your team and your family!
Jim
Jim,
This is such an important question because there is actually a way to detect many of these rumors or major events (outside earnings reports) that can impact share price without spending dozens of hours a week researching rumors on all eligible securities.
The answer lies in the implied volatility of the underlying security. The “big boys” (mutual funds, hedge funds, banks and insurance companies) have teams of analysts scouring expensive software programs to locate these rumors and events. They then act accordingly and that’s what moves market pricing of options.
Here’s how it works for us and other retail investors. The big boys dictate option-pricing based on their research and perhaps information not available to us. We let them do the legwork and simply view option pricing. We don’t even have to look up implied volatility stats. All we need to do is look at option returns for near-the-money strikes based on stock price. I refer to this as “ROO” in my books, calculators and DVDs…return on option which reflects time value only. If we see an extremely high ROO…stay away…something is up. We can research from there, if interested. In my material, I suggest setting an initial return goal based on personal risk tolerance. Mine is 2-4% per month in my accounts and 1-2% per month in my mother’s account. If an option return is >6% for the month, I stay away…too risky.
The big boys can do the legwork for us and we take advantage of their efforts to minimize risk.
Alan
Jim,
We do add notes to the Weekly Premium Report when we see potential M&A activity. When I see a chart with an unusual chart pattern, I immediately check the news. If there is M&A activity, I enter a note in the “Comments” column on the Weekly Premium Report.
Best,
Barry
Premium members: “Long-term, Investing”
The Blue Hour #3 recording from December 1st is now available on the member site. Login and scroll down on the left side. The first two Blue hour webinars are also available in that same area.
Alan
My question pertains to the flow-chart attached to this question:
I have read your “Selling Cash Secured Puts” book. Forgive me if this question is answered in there and I’ve somehow forgotten, but here goes.
Under the “Gap Down In Price” it says, “Write Call If News Not Extreme.” I could see that as part of the Put-Call-Put strategy. But, prior to expiration this confuses me for the following reasons:
If the put hasn’t yet expired ITM I’m potentially left naked if the stock should gap up OTM again. On the other hand, selling the call would seem premature as that could lock in a guaranteed loss (of course depending on the severity of the decline, but gaps being what they are I’m assuming possibly several percentage points) or may fetch a very small premium with the share price currently being depressed (potential increase in IV notwithstanding).
I could potentially see selling an additional lower strike put with an anticipated rise in share price, but doubling down on a trade that’s going against me would not seem to be the best capital preservation strategy.
The only logical thing my tiny brain can muster here would be that it is intended to wait for assignment and then write against it (again the PCP strategy).
Would you be willing to clarify the point? I apologize for being long-winded here.
Thanks a bunch!
Geoff
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Geoff,
The flow chart (found in the “resources/downloads” section of our premium site) relates specifically to the information found in my “Selling Cash-Secured Puts” and the associated DVD Program.
The specific strategy referenced in your question is found on page 140 in the 3rd paragraph from the top:
…we can take an alternative path by accepting assignment of the shares at expiration and writing out-of-the-money covered call options….”
I share your concern about writing both calls and puts on the same stock without actually owning the underlying but that is not what the chart intended. Writing the call implies that we decided to accept assignment when stock news was not egregious and we opted to write calls to continue the cash flow. We also have the other choices listed in the book and flow chart.
Looks like your brain should be given a lot more credit!
Alan
Alan,
I am great Fan of you & want to thank you for the knowledge imparted to us.
My question is that does Volume holds significance when there is huge intraday trading volumes included in it & delivery percentage is very low.Many times we observe that delivery percentage is as low as 20% with huge volumes & the stock is in uptrend/downtrend.
Regards
Jitin
Jitin,
You make an excellent point but our system protects us from these unusual scenarios. We know that, unlike options where the underlying is delivered less than 20% of the time, stocks are almost always delivered…a buyer wants to buy and a seller wants to sell and a transaction occurs with ultimate delivery of the underlying.
So what does it mean when we see high volume and very low delivery as it relates to stocks? This usually falls into one of 3 categories:
1- Lots of day-trading going on with no intent to actually own the underlying (most common)
2- IPOs
3- Newly-listed stocks
IPOs and newly-listed stocks don’t have the history necessary to gain entrance onto our watch lists. Stocks that are day-traded usually are volatile stocks with a risky story or event that makes this type of trading worthwhile to investors with high risk-tolerance. These scenarios would result in high premiums (implied volatility) and most conservative investors would be concerned regarding the high premiums…see my response to Jim above).
Thanks for a great question.
Alan
Alan, Thanks for your last weeks replies, and yes I guess it is a bit of a lost opportunity to generate more profit from that “SNV” stock I told you of, whereby had there been enough liquidity I could have done a MCU from it.
So I want to ask a brief question on this first, with my last others thrown in there too:-
I was thinking perhaps I should look at some other strikes (that are around the particular strike I will choose) to see that there is enough O.I., and around 0.30c or less B/A spread?(rather than just my strike, – because previously my strike did have enough liquidity to make it worthwhile to consider trading with it?)
2. For this ‘SNV’ stock again, there wasn’t to be any dividend mentioned when I bought it. But now 2 weeks later I just happened to be on a recent premium report, and saw that there is one. So I am guessing it would be a good idea to keep checking each weeks premium report, just in case there is a dividend date added(or deleted) during the contract, so in case of early exercise?,- isn’t this what we should all do?
3. After you had answered all my calculation questions a while ago, it seems to me that the 2-4% margin cash you say to have might not be enough for a MCU(or DMCP) exit strategy, if the replacement stock value is much higher than the stock just sold?Like what if I sold the 1st stock for $20, but then bought replacement stock at $50, – I would need another $3,000 for 1 contract, yet if my total portfolio is $25,000 then wouldn’t this then represent needing another 12% as exit strategy cash?
4. Also is this MCU strategy a hardened rule we should go by?
If at mid-contract I calculate it not being worth doing a MCU, but then the stock continues rising in the following days, then would you not allow maybe another 2-3 days or whatever to keep trying to do a MCU, so to go to a replacement stock?
And on that last question, I have actually just found another stock for this Last weeks contract, after closing out the last one as price was up quite high. I didn’t believe I was actually going to find one, but ‘CPE’ was the one, – I know it’s not exactly a MCU but still it’s more profit!
Have a great Xmas for you and family, and thanks too for all the help you have shown me this whole year. Will be back next year for learning more too! Thanks
Adrian,
1- I’m not sure I fully understand question #1 but if you are referencing buying back the option, it must be the same exact strike and date you initially sold. When entering a trade, it is definitely okay to explore all strikes with adequate OI and B-A spreads that meet your initial return goals.
2- If early exercise is a concern, it is a good idea to check the reports to see if there is an upcoming ex-dividend date. The most likely scenario for early exercise would be if:
– The ex-date is close to contract expiration
– The strike is in-the-money
– The time value component of the premium is greater than the dividend about to be distributed
I’ll come back to 3 and 4.
Alan
Adrian,
3- When there is a huge gap-up, there may be a need to add additional; cash or close a position to allow for the MCU strategy. I don’t like setting aside such a large amount of cash not working for us on a regular basis so I create the cash when the opportunity arises. Generally, I set aside 2-4% of my portfolio value.
4- An excellent guideline to use for MCU is that if we can generate at least 1% additional profit for the month (in that position) MCU is a viable opportunity. If not, I leave the position and re-evaluate as expiration approaches for possible rolling opportunities.
Alan
Running list stocks in the news: AMAT:
Applied materials is a leading equipment supplier to the global semiconductor industry. On November 17th, AMAT reported a stellar 4th quarter earnings report beating earnings-per-share estimates by one penny and raising earnings guidance by 154% year-over-year. The only blemish on the report was a slight shortfall in revenues. The company has beat earnings consensus in 5 of the past 6 quarters. Although the stock price is up 71% this year, it trades at a reasonable PE ratio of 13x forward earnings. See the bullish chart pattern under this comment.
The BCI Premium Report shows:
Located in the Chips industry ranked “A”
Scouter Rating of “7”
Beta = 1.48
% dividend yield = 1.20
Weekly options are available
Adequate open interest for near-the-money strikes
Next projected earnings report date: 2/16/17
Next projected ex-dividend date: 2/17/17
For new members: “running list stocks in the news” comments are not necessarily recommendations but rather interesting news events regarding a stock that has passed the rigorous BCI screening process.
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Alan
Those who know me here value me as a contrary indicator :). I predicted both the post Brexit and post Trump market crashes which of course turned into rallies!
So I predict a Janet rally tomorrow after she raises rates :).
I have been buying stock and selling cash secured puts on the rare down days then covering the stocks after they bounce back giving me upside room.
I would not mind a few down days this week. We need it. – Jay
Looks like you got it right this time Jay, congrats.
Roni
Thanks Roni,
Every blind squirrel finds an acorn some time :).
I sold cash secured OTM puts on IWM and QQQ yesterday for January grabbing the rare down day when I could. They are already on their way to my profit target with the ever present help of time decay.. – Jay