Covered call writing and selling cash-secured puts are similar strategies that do have certain differences. In my book, Selling Cash-Secured Puts, Figure 68 on page 214 highlights the similarities and differences between these two strategies. In this article, I will show a real-life example of how analogous positions in each strategy frequently will yield similar returns with similar protection and therefore comparable risk-reward profiles.
Trade data
To demonstrate the mathematics of our two positions we will use the following data obtained from an options chain for Adobe Systems, Inc. (ADBE) on 12/29/2015:
- ADBE is trading at $93.66
- We are hypothetically bearish on the market and will favor in-the-money calls and out-of-the-money puts
- The February 19, 2016 $92.50 call trades at $3.90 (see screenshot below left side)
- The February 19, 2016 $92.50 put trades at $2.60 (see screenshot below right side)
- Option chain data will be calculated by the Ellman (BCI) Calculators
Call calculations
Calculating Call Returns for ADBE
Put calculations
Put Calculations for ADBE
Similarities in returns
- Call returns (ROO or time value only) comes in at 3.0% while the ROO for the put positions calculates to a similar 2.89%
- These are both the maximum profits achievable
Similarities in protection
The Ellman Calculator for covered call writing (top chart) shows a downside protection of 1.2%. This relates to protection of the initial profit or ROO (3.0%). You will note that the actual position breakeven is $89.76 which represents 4.2% of protection down to breakeven ($3.90/$93.66). On the lower screenshot of the put calculator we see a breakeven (stock cost basis, if exercised) at $89.90, a 4.01% discount from $93.66.
Discussion
Comparable covered call writing and put-selling positions will generate similar risk-reward profiles. In the real-life example presented in this article, both put and call strikes were $1.16 either in- or out-of-the-money. Both positions yielded returns near 3% with protection to breakeven of near 4%. It is certainly to our advantage to master the similarities and differences between these two strategies so we may take advantages of their strengths and weaknesses.
April 20, 2016
Solutionsology Radio interview Part II
9 PM – 10 PM
Discussion about my third book, The Complete Encyclopedia for Covered Call Writing
April 26, 2016
Options Industry Council Panel Discussion on Income Generation
4:30 PM ET
Link to follow
Market tone
- Global stocks rose this week as China’s economy showed more signs of stabilization. The Chicago Board Options Exchange Volatility Index (VIX) fell to 13.90 from 15.20. Oil prices rose on hopes for production caps from major oil-producing nations at a meeting in Doha this weekend. This week’s reports and international news of import:
- In China, industrial production, retail sales and fixed asset investment all rebounded in March following disappointing reports in February
- A Brazilian congressional committee recommended impeachment earlier this week to remove President Dilma Rousseff from office
- Claims for state unemployment insurance fell to their lowest level since 1973, a bullish signal for our economy. Only 253,000 first-time claims were filed
- Global oil supply will move closer to balance late this year, according to the International Energy Agency. The oversupply is expected to fall to 200,000 barrels per day from 1.5 million barrels per day in the first half of 2016
- The global economy is expected to grow 3.2% in 2016 and 3.5% in 2017, according to recent International Monetary Fund projections
- The Italian government agreed on a draft plan to support the banking system
- British prime minister David Cameron finds himself embroiled in the Panama Papers scandal as he tries to lead the “remain” campaign ahead of the June 23rd referendum on UK membership in the European Union. The average of six recent polls points to a statistical dead heat.
- US banking regulators gave failing grades to five of the eight largest banks in the United States on their bankruptcy and liquidation plans in the event of the banks’ failure. The plans were a requirement of the 2010 Dodd-Frank Act. The five banks have until October to amend their plans to the satisfaction of the US Federal Reserve and the Federal Deposit Insurance Corporation
- Earnings season kicked off this week. While only a small fraction of S&P 500 companies have reported Q1 earnings, early results have been excellent as 79% reported earnings that exceeded analyst expectations, while 21% reported earnings below expectations
THE WEEK AHEAD
•OPEC and non-OPEC oil producing countries meet in Doha on Sunday April 17th to discuss a production cap
•The spring meeting of the International Monetary Fund and the World Bank concludes on Sunday April 17th
•New York Federal Reserve Bank president William Dudley speaks on Monday April 18th
•The European Central Bank holds a rate-setting meeting on Thursday April 21st
For the week, the S&P 500 rose by 1.62% for a year-to-date return of 1.80%.
Summary
IBD: Market in confirmed uptrend
GMI: 4/6- Buy signal since market close of March 2nd
BCI: Moderately bullish, favoring out-of-the-money strikes 2-to-1. A good first week of earnings season.
Wishing you the best in investing,
Alan ([email protected])
Premium Members,
This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member website and is available for download in the “Reports” section. Look for the report dated 04/15/16.
Be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar Investor YouTube Channel. For your convenience, the link to The Blue Collar Investor YouTube Channel is:
http://www.youtube.com/user/BlueCollarInvestor
Since we are in “Earnings Season”, be sure to read Alan’s article, “Constructing Your Covered Call Portfolio During Earnings Season”. You can access it at:
https://www.thebluecollarinvestor.com/constructing-your-covered-call-portfolio-during-earnings season/
Best,
Barry and The Blue Collar Investor Team
Alan,
I had a covered call position and the status AFTER the end of the contract is:
· I still have the stocks of a specific company
· The specific company is in the table “PASSED PREVIOUS WEEKS & FAILED CURRENT WEEK ”
I would like to know your recommendation for the above scenario (i.e. should I sell the stocks or should I do something else).
Thanks in advance
Amir
Amir,
If the stock was eligible the past week and not the current week (1st week of the new contracts), it is due to technicals breaking down. The charts are providing a red flag. Generally, it is best to sell the stock and move on to a stronger candidate. If we still like the stock despite the failing technicals, plan B would be to write an in-the-money call as deep as possible that still meets are monthly goal.
Alan
Alan,
I read that article of yours:
https://www.thebluecollarinvestor.com/leaps-and-covered-call-writing/
How about this: Buy to open stock with a ATM put expiring in 2018. Then sell weekly calls. I really like high volatility and risk stocks for this. CHK, AKS and other depresses issues paying 4% a week for a call.
The idea is to pay off the cost of the put and then keep milking those calls for a while.
What do you think?
Thomas
Thomas,
The risk with this approach is when share value increases:
1- Weeklys calls will be exercised (if not rolled) and shares will need to be re-purchased at a higher price,.
2- The once ATM put is now OTM.
3- Put value declines representing a loss if long put position is closed.
The strategy works well if share value remains the same.
Alan
I am interested in your newsletter but I wanted to confirm what amount I should have in my brokerage account to apply your investment strategies.
Doug,
As a guideline, for proper diversification, we need $10 – $15k with exchange-traded funds and $25 – $35k for individual stocks. Even when our portfolios are not yet appropriately funded, the learning process can start today.
Alan
Hi Alan
Hereafter the result of ROO for some options that I would like to trade (simulation) today when the market will open.
Since the market is still closed: for stock price I’m using the LAST (Am I Right?). If yes you can notice on the line of ITM of “G” that the ROO is negative (see chart).
Am I doing something wrong? I’m using the data from OptionStation Pro by TradeStation.
Thanks and best regards
Mauro
(click on Mauro’s chart to enlarge & use the back arrow to return to blog)
Mauro,
1- Using “last” over the weekend to get an idea of potential returns is reasonable. When market opens we look at “ask” prices.
2- G is showing a negative ROO in your chart because there is no time value for this deep ITM call. If we pay $28.04 for a stock and agree to sell it for $25.00, we are losing $3.04 on the stock side. On the option side, we generate $2.70 netting a loss of $0.34 representing a negative ROO of 1.4%. When we sell ITM strikes, there must be a time value component that meets our monthly (or weekly) goals or we should pass on that trade. Had the premium been $3.70, we would have a time value component of $0.66 representing a positive ROO of 2.6%.
Alan
Live interview on Wednesday:
I will be interviewe3d live on Wednesday at 9 PM ET. Here is the link to listen:
http://bit.ly/1qBsNMI
Alan
Alan,
Who should we trust? I was looking at selling covered calls on USCR. The Premium was pretty high for the near term calls so I checked the earnings date. On the premium report it has June 2 which Earnings Whisper shows too. On Yahoo Finance and Nasdaq.com it has an estimated date of May 5. Which one should I trust? I like the return but I don’t want to be caught In an ER potential problem.
Thanks Nate
Nate,
Earnings dates have always been one of the biggest challenges for BCI because of the conflicting data. That’s why we suggest checking ER dates before entering trades (as you have done). The last ER date for USCR was 3/3 so 6/2 would be 3 months later. However, if multiple resources suggest 2 months since the last report, I would defer until after the 5/5 date. Another approach would be to check the corporate website. Over the years we have found earningswhispers.com to be the most reliable of all resources for earnings reports but it is not perfect.
Alan
Alan
I did check the history of earnings reports for USCR and it looks like for the past 5 years there is a 2 month gap every year reporting early March and early May. So history tells me it will be early May again.
Shoot, and no weeklies either so I will have to pass on this until perhaps after earnings like you suggested or find myself a different soldier. Thanks
Nate
Premium Members,
The Weekly Report has been revised and uploaded to the Premium Members website. There was an update to the ER dates for ROST and USCR. Earnings Whispers, our “source of truth’ for ER dates was not aware that for this quarter, both stocks are only reporting 2 months vs. the normal 3 month interval. For the stock THO, there was an incorrect IBD industry segment. That has now been corrected.
Look for the report dated 04/15/16-RevA.
Best,
Barry and the Blue Collar Investor Team
Hi Alan,
I am an Aussie who has been trading the ASX using the covered call strategy for about 10 years with some success, however I would like to get on to the American stock market, how do I do that?
Best regards,
Ana
Ana,
Check our online discount broker file. Many of these brokerages allow international investors to trade on US exchanges. BCI is fortunate to have numerous investors from Australia doing just that. All the contact information is in that file.
Alan
Friends,
An interesting Technical milestone today: we closed above 2100 S&P and 18,000 Dow for the first time this year! I hope your long positions are beneficiaries. Tough day for NFLX, IBM and a couple correlated Techs but they have had plenty of time in the sun – no tears from this humble blogger :).
It’s one of those years where a Lineman could win MVP. The components of XLP and DVY are solid winners. They are always great candidates for cash secured puts and covered calls playing the artful dodger around earnings and ex div using weeklies. This year perhaps even more so….
Election year seasonality tails off about now in contrast to normal year seasonality which still has time.
If market timing is a fool’s errand this fool is staying the course. No portfolio building at a juncture like this when punishment seems more likely than reward. But no selling either. – Jay
Alan,
Perhaps well probably I am doing something wrong but I cannot get my portfolios filled during earnings season. There just don’t seem to many suitable stocks so that I need to look in the less suitable and thus riskier stocks. Is it possible to also give a list of the worst stocks which would then give a possibility of buying a Put or selling a cash covered Call? Thank you very much for your time on the whole the portfolios perform very good!
Johanna,
Funding a portfolio in the heart of earnings season is always a challenge for us but not an insurmountable one. In addition to the 8 eligible securities that do not report this month (make sure there is adequate option liquidity and returns meet our goals), note that 11 securities (1st 11 on our “running list”) report in this 1st week of the current 5-week contract. Once these reports pass, there is still 4+ weeks of time value to capture. We also have all the ETFs eligible for consideration. In addition. for the stocks that have Weeklys we can add candidates to our portfolio as described ion this article:
https://www.thebluecollarinvestor.com/how-to-use-weeklys-and-the-premium-stock-reports-for-covered-call-writing-during-earnings-season/
Alan
Johanna,
You will also note that the stocks that report in the first week of a contract are colorized slightly differently in our reports from the ones reporting later in the contract month.
Alan
Alan,
I had a situation happen today that might be worth sharing. I had set up a covered call trade that originally was 45 DTE (there was no weekly and 45 was the shortest expiration date) It looked good so I set it up although the time frame was a bit long. I was 30 days from expiration when this happened.
Like a knucklehead I did not recognize that a earning report was in the middle of the 45 days. With some luck the news was very good and the stock shot up $7.00 a share from what I got in!
So I’m looking at this nice jump in appreciation that I can’t take advantage of due to the CC I have in place that limits the profit that I can realize (appreciation up to the strike price plus the premium I collected), bummer. After a closer look I realized that I could buy back the call option (at a loss) and then sell the stock at a nice profit. The total was just under the amount that I would have netted in the original trade that I set up. I decided to close the trades and take the money and run. I can now move on to another trade instead of waiting the additional 30 days for the trade to work thru.
You don’t have to stay in the trade to the expiration to recognize the potential of the trade!
Best, Roger
Roger,
That is the beauty of the mid-contract unwind strategy. I have used it many times to generate a second income stream with the same cash in the same month. – Emily
Emily,
Great comment…you hit the nail on the head. For those not familiar with this very important position management technique:
1- Pages 264-271 of the Classic version of the Complete Encyclopedia
2- Pages 243-252 of Volume 2 of the Complete Encyclopedia
Congratulations to Roger and Emily for taking advantage of this strategy…you made my day.
Alan
Allan,
I subscribe to your list, but a lot of your stocks are way out of my price range. Do you have any recommendations for stocks under 10?
Elliot
Elliot,
Rarely are there stocks priced under $10 that meet our strict system requirements. HOWEVER, if you use ETFs (as I do in my mother’s account) you will not need as many positions to diversify (2-3 should do it). The new ETF Report is just out and you will find 11 securities priced under $30 with $16 the lowest price.
Alan
Premium members: ETF report/Important notices
This week’s 8-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.
Additional important notes:
1- We have made a few minor changes to the latest stock report and uploaded it on the member site. These are the changes:
• ROST: ER date changes to 5/19/16
• USCR: ER date changed to 5/5/16
• THO: IBD Industry segment changed from “Real Estate” to “Building”
2- I will be interviewed live tonight at 9Pm ET on Blog Talk Radio (all welcome):
http://www.blogtalkradio.com/everydayradio/2016/04/21/interview-w-legendary-investor-alan-ellmanpres-of-blue-collar-investor-part-2
3- This weekend’s stock report will be available later on Sunday due to the Jewish holidays
4- We have also uploaded the 2nd quarter High Dividend Yield Stocks with LEAPS Report
NOT A PREMIUM MEMBER? Check out this link:
https://www.thebluecollarinvestor.com/membership.shtml
Alan and the BCI team
Alan,
I have a couple of reasons for writing: 1, to make a comment and 2, to ask a question.
I attended your AAII presentation in Denver last summer and was intrigued with your method and ended up buying two of your books (which I have read and re-read several times.) I also signed up for the Premium Membership and have been paper trading covered call options since September. For the first few months, I didn’t do well but for the past 2 months, the picture has looked much brighter. I know the market tone has affected my results but I have also learned significantly. I have also had a good time even though I am not into real money yet. Thanks for getting me started.
My question has to do with the P&L spreadsheet accounting procedures in cases of rolling out and up. I rolled out and up with a couple of stocks during the April contract period. One in particular was the ETF, GDXJ. I bought the fund at $27.16 and sold a 27 call for $1.35. Close to expiration day, the ETF price had risen to $31.69 and I decided this position was a candidate for rolling out or rolling out and up.
I bought back the option for 5.00 and sold a May 31 Call for $2.20. The “bought up value” at closing was 4.00 giving me a $1.20 net profit for a 4.40 % return.
My question is “What profit value do I enter in the P&L?” Since the total profit includes unrealized gains that won’t be generated until I sell the stock, my inclination is to exclude the “bought up value” when I enter the net profit in the P&L. However, when I do this with the above transitions, I would enter a loss of $2.80. It doesn’t seem possible to realize a positive profit during the May contract period with this position unless I sell the ETF during May and then would end up in the black only if the ETF’s price holds up.
Any comments to help my understanding would be appreciated.
Richard
Richard,
There are two types of calculations:
1- The ones I developed with our calculators which assist us in making the best trading decisions at any given point in time. You did quite well from this perspective by maxing your initial trade with GDXJ and then rolling out-and-up where you lost $2.80 on the option side and gained $4.00 on the stock side (from one strike to the other). That nets an initial return of $1.20 on a cost basis of $27 for a 1-month additional (initial) return of 4.4% If GDXJ remains above $31.00 that’s your second income stream. This is above the 4.4% you generated with your first covered call trade.
2- P&L calculations (check with your tax advisor on the comments I am about to make):
The initial option was sold and then closed (acquisition date after sale date) prior to contract expiration. That trade shows up as a loss on a P&L spreadsheet or Schedule D ($5 – $1.35 or a loss of $3.65). Share value at this point in time (before selling the second option) is $31.69. Your unrealized share appreciation is $4.53. Now you sell a $31 call and so both the short option and long stock positions are open so P&L cannot be calculated until closed. Management skills will bring us to the highest possible levels of success.
Alan
I wanted to ask you a question :I sold a covered call on a stock i owned @28$ per share for 30$ month of May . The stock quickly went up to 32$ . I rolled out and up still October at the same 30$ strike same . Was that the best move if i want to keep the stock.Is there any repercussion for rolling up that far out?
Leroy
Leroy,
Rolling out (forward) 6 months has the advantage of generating an enticing option premium up front. The potential disadvantages:
1- We will be garnering a lower annualized return when compared to writing Monthlys (or Weeklys when applicable).
2- We are undertaking a longer-term commitment on a security we like now but which may not meet our criteria months down the road.
3- We are holding a covered call position through multiple earnings reports. One of the most important of our BCI rules/guidelines is never to write a covered call (or sell a put) when there is an upcoming earnings report prior to contract expiration.
Alan
Alan,
I see the stock PRAH is in the last list for the calls, however the earning date seems to be on the 27th of April…. shouldn’t be all the stocks in the list away from the earnings?
regards
Alex
Alex,
Note that PRAH (and many others) are located in gold, not white, cells, This is to ensure that our members are aware that the stock is not eligible until the earnings report passes. Once the 4/27 date passes, assuming the stock still meets all other system criteria, PRAH will then appear in the white cells.
Alan