The covered call writing and put-selling premiums we receive are directly related to the implied volatility (IV) of the underlying securities. This is true of both stocks and exchange-traded funds (ETFs). How do we manage elite-performing securities that generate extremely high returns for near-the-money strikes? In other words, can we use these securities and mitigate the risk of the high IV? Of course, the answer is “yes” or I wouldn’t be writing this article. On January 18, 2021, Barry R. wrote me an email:
Alan,
I am evaluating new stock purchases to sell calls on.
The list is limited because of earnings reports. I evaluated ETFs.
ICLN strike 30 has ROO 6.8%.
PBW strike 120 has ROO 7.8%.
LIT strike 68 has ROO 6.4%.
YOLO strike 22 has ROO 9.1%.
These are all for exp 2/19.
This doesn’t make sense that the ROO is so high.
What am I missing?
Barry R
The ETFs Barry was alluding to were taken from our premium member ETF Report dated 1/13/2021.
Premium member ETF Report showing the IV of the 4 ETFs
ETF Report Dated 1/13/2021
Note that the IV of the 4 ETFs range from 56.92 to 73.56 (brown cells) while that of the S&P 500 is 18.35 (blue arrow).
Mitigating risk with in-the-money call strikes
Let’s turn to the 1-month option-chain for LIT ($68.30):
LIT Option-Chain on 1/18/2021
With LIT trading at $68.30, we will look to target a deep in-the-money strike that will generate a significant 1-month initial time-value return while simultaneously offering compelling downside protection of that time-value profit and lowering the breakeven to a comfortable level. In this case, we will calculate the returns for the $61.00 strike.
LIT calculations using the Ellman Calculator
LIT: Initial Returns and Protection
Using the $61.00 deep in-the-money strike still generated a 1-month initial time-value return of 2.3% (yellow cell) with downside protection of 10.7% of that time-value profit (brown cell). The breakeven is lowered from $68.30 to $59.60.
Discussion
Mastering the 3-required skills for option-selling will give us the ability to convert potentially risky trades to more defensive positions while still generating significant time-value returns. In this case with LIT, we used a deep in-the-money strike to position ourselves favorably in both areas.
Our best calculator for selling calls and puts
Your generous testimonials
Over the years, the BCI community has been incredibly gracious by sending our BCI team email testimonials sharing stories as to what our educational content has meant to their families. Moving forward, we have decided to share some of these testimonials in our blog articles. We will never use a last name unless given permission:
Hello Alan and team!
Today’s email alert about adding additional implied volatility information to our stock reports is exciting- the benefits of being a BCI Premium member just keeps getting better!
Thank you,
Jim
Upcoming events
1. Wealth365 Investor Summit
July 12th at 5 PM ET
Covered Call Writing with Invesco QQQ Trust (Nasdaq: QQQ)
Multiple Applications
Weekly and monthly cash flow can be generated by selling call options against shares of large-cap technology companies. QQQ is an exchange-traded fund consisting of 100 of the largest non-financial companies listed on the Nasdaq exchange and frequently an outstanding security for option-selling.
This presentation will include the basics of covered call writing, spreadsheet calculations and the rationale for entering these trades in various market conditions.
This webinar will also detail how to implement the covered call writing strategy with QQQ in 3 types of market environments:
- Normal-to-bull markets
- Bear or volatile markets
- Low interest-rate environments
VOLQ (30-day implied volatility of the Nasdaq 100 index (NDX) will be introduced and applied with real-life detailed examples.
2. Money Show Virtual Expo
July 15th
2 PM – 4PM
2-hour Money Masters Course (paid event to The Money Show)
4 Practical Applications to Selling Cash-Secured Puts
***********************************************************************************************************************
Market tone data is now located on page 1 of our premium member stock reports and page 1 of our mid-week ETF reports.
****************************************************************************************************************
Alan,
Do you ever roll your put options when you use your weekly 10 delta strategy?
Thanks,
Dennis
Dennis,
Interesting that I’ve had several BCI members recently inquire about this.
Generally, no, I do not roll these options so as to avoid weekend risk. I implemented this strategy about 10 months ago with impressive results. Twice, my puts were exercised with the stocks sold the following week generating significant profit.
I am now testing one minor tweak to the strategy by rolling my put positions on Fridays when Monday is a market-recognized holiday. Since there isn’t a large database of these scenarios, it will take some time to assess the benefit or liability of this approach. For example, I rolled 12 put positions this past Friday to the 7/9 expirations.
When I feel I have dependable conclusions, I’ll report back to our BCI community.
Alan
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 07/02/21.
Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them on The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:
http://www.youtube.com/user/BlueCollarInvestor
On the front page of the Weekly Stock Report, we now display the Top Performing ETFs, the Top SPDR Sector Funds, and the 4 single Inverse Index Funds. They are sorted using the 1-month performances from the Wednesday night ETF report and the prices from the weekend close.
Please make sure that you review the new feature that we’ve added…Implied Volatility or IV. This is the At The Money (ATM) Implied Volatility for all of the stocks in the report.
Best,
Barry and The Blue Collar Investor Team
[email protected]
Alan,
I recently read your article using VOLQ with the Qs. Thanks for another fantastic article.
You used a factor of 3.46 to determine the range for monthly options. My question is what factor would you use to get the range if I used weekly options which is what I prefer?
Thanks for all you do.
Lisa
Lisa,
In order to match VOLQ (expected trading range of the Nasdaq 100 over the next 30-days in an annualized stat based on 1 standard deviation) with the length of the contracts we are selling is to divide VOLQ by the square root of the number of expiration time-frames in a year.
For monthlys (in the article), it is the square root of 12 or 3.46. For weeklys, it is the square root of 52 or 7.21. We divide these stats into the published VOLQ to get an expected % trading range, up and down, for the security over the length of that specific contract.
These calculations are a bit intimidating initially but after using them a few times, it will become second nature.
Alan
Hello Alan,
I need your advice:
I was looking at the Blue Chip Report and released that most of them have Earnings Release soon. How are we suppose to use them?
Regards
Dennis
Dennis,
The best way to navigate around earnings dates for the Dow 30 stocks is to use weekly expirations the month of earnings releases and skip the week of the earnings report announcement. This will allow us to sell options on these securities 48 weeks out of the year.
Alan
Alan, Barry,
I’m fairly new covered call guy here. I always look forward to the weekly screening report.
Why does the weekly stock screening report only include selections around the ER date? Why not use stocks (for example) that have an ER in April or December?
Thanks
John
John,
Our weekly stock report includes eligible securities that have upcoming earnings over the next 3 monthly expirations.
The solid and broken black lines delineate expiration months starting with the nearest to the furthest out.
Alan
John,
Another point to consider is that the ER dates beyond three months are just estimates. The confirmed ER date is indicated in “Red Bold” only after the company in question releases a News Release announcing the actual ER date.
Best,
Barry
Alan,
Example–
I buy ABC @ $100. and sell option about 30 days out at with strike at $105. 1-2 weeks later it has dropped to $95 and hangs around there. My option expires OTM.
My choices are…
1)sell the stock at a loss and move on, 2)resell the same $105 option for the next month but at a lower price usually 3)resell the option but at a lower strike price (usually lower than what I bought the stock for) and risk getting assigned at a loss or having to buy it back at a loss or very little gain 4)sell an option at $105 but several months out to get a better price and make a little on the stock
My question is … if I buy a good stock (passes all the tests) and it goes down 20% or so and stays there for several months, I can still make money on the option but have to be careful I don’t get too close to the ATM strike …. or I can sell an option 6 months out and wait it out.
How often do you sell an option more than 30 days out?
How long do you stick with a stock that is priced 20-30% lower than you paid for it and you are making less and less on it every month?
Thanks,
John W
John,
In your example, the stock dropped 5%, and you may have received a 2% premium. Therefore, in my opinion, the best choice is the first choice; sell the stock at a 3% loss, and move on.
If you choose to mitigate, you will probably be waiting another 4 weeks, and hoping to end up with a frustrating zero-sum result.
Roni
John,
As Roni stated, the stock dropped 5%, not 20% – 30%. We may retain a stock that has dropped 5% but not one that has declined 20% – 30%. In the latter case, we would have been out of that position well before the final drop price.
In the 5% example, eliminate choice #4 which would bring us through multiple earnings reports and decrease our annualized returns. We consider retaining the security based on our screening parameters. Is the share decline a result of overall market decline and not specifically corporate- related? If so, we may opt to retain the stock. If the stock is under-performing the market and chart technicals look poor, we may sell and move to a better-performer.
Strike selection is based on our initial time-value return goal range and has nothing to do with the initial higher price, or any past price, we paid for the stock.
I will almost never retain a stock that has dropped 20% – 30% and rarely go more than 1-month out in my option-selling portfolios.
Alan
Hi Alan,
I am watching your video “20. Rolling Down When There is a General Market Decline” and am trying to distinguish when to roll down vs. when to convert dead money to cash. Am I understanding correctly that I should be more inclined to convert dead money to cash if the stock is dropping but the market is either flat or increasing? You also say to sell the stock if it is significantly under-performing the S&P 500. What would be considered significant under-performance?
When using the 20%/10% rule on ITM calls, is the calculation based on the total option premium or only on the time value?
Hope you have a great week!
Best regards,
William
William,
If the 20%/10% BTC thresholds have been reached and the short calls closed, we check the news to see the reason for the decline especially when there is an under-performance relative to the S&P 500. If no specific negative news is found, I will favor waiting to “hit a double” early in the contract and rolling-down later in the contract. If the divergence between the 2 continues, I consider CDMCP.
There is no specific guideline divergence % for when to sell the stock but rather a pattern. For those looking for a specific guideline % when to sell the underlying, a drop of 7% – 8% from when the trade was entered is reasonable.
The 20%/10% guidelines are based on entire premiums including intrinsic-value for ITM strikes.
Alan
Alan,
Sorry to bug you. But I could not figure out from your e book where to put stop loss order. I would like to place a stop order where stop will not trigger before I get a chance to roll down the position. Can you suggest me how far below the stock trade trade price, we should put a stop loss order?
Thank you’
Jash
Jash,
Our covered call trades incorporate 2 positions… we are long (own) the stock and short (sold) the call. When instituting exit strategies, we must first close the short call so the stop is placed on the option side of the trade.
In the BCI methodology, for declining share prices, we set up buy-to-close limit orders on the short calls immediately after entering the trades. This is based on our 20%/10% guidelines detailed in the exit strategy sections of my books and online videos.
If and when these thresholds are met and the BTC trades are executed, we will have the flexibility to roll-down if that is the best path to take.
Alan
Hello Alan,
Can you advice on the Strike Price for the Protective Put?
Are you suggesting the same Strike Price as the Covered Call?
Regards
Dennis
Dennis,
Typically, the collar strategy consists of an out-of-the-money (higher than the price of the stock) call and an out-of-the-money (lower than the price of the stock) put.
The net premium should result in a credit that aligns with the strategy initial time-value return goal range. The BCI Collar Calculator will assist with the trade structuring.
Here is a link to an article I previously published on this topic:
https://www.thebluecollarinvestor.com/protective-puts-and-the-collar-strategy-selecting-the-best-strike-prices-last-chance-for-holiday-orders/
Alan