After entering our covered call writing or put-selling positions, we immediately prepare for possible exit strategy opportunities. All exit strategies begin by buying back the option, call or put. These position management techniques are used to mitigate losses, turn losses into gains and enhance winning positions to even higher levels. This is the reason we need to have a cash reserve in our brokerage account. A reasonable guideline is to set aside between 2% – 4% of the portfolio value for potential exit strategy executions. Our main concern after selling covered calls or cash-secured puts is share value decline. When the stock or exchange-traded fund price declines significantly, buying back the option frequently will make sense. The cost to close short calls and short puts will differ dramatically and we must be aware of this disparity and understand they exist.
When stock price declines the cost to close calls decreases
Call options have positive Deltas in the range of 0 to +1. A call buyer benefits from share appreciation and therefore the option increases in value as share price accelerates and decreases in value as share value declines. If the call option holder bought a $30.00 strike and share price moves from $30.00 to $25.00 that right to buy at $30.00 becomes less valuable. If a covered call writer sold that option, the cost to buy it back (close the short call) would generally be lower than the price generated from the original option sale. These concepts are the basis of our 20%/10% guidelines for covered call writing. and our 3% guideline for put-selling as detailed in my books and DVDs.
When stock price declines the cost to close puts increases
Put options have negative Deltas and range from 0 to (-)1. A put holder benefits from share value decline and so put options increase in value as stock prices decelerate. If the put buyer bought the $30.00 put and share price moves down from $30.00 to $25.00 that put is worth much more. As put-option sellers, it would cost more to buy back that short put and there would be a net option debit cost-to-close. This means it would require more cash on hand to execute exit strategies resulting from share price decline for puts compared to the amount needed had calls been sold. These concepts are the basis of our 3% guideline for put-selling as detailed in my books and DVDs.
When stock price increases the cost to close calls increases
When share value rises, Delta moves option value higher as well. This is a positive scenario for option sellers. We may still want to close our short calls if the time value cost-to-close approaches zero. This is the basis of our mid-contract unwind exit strategy (detailed in both versions of The Complete Encyclopedia). By closing the short call there will be share appreciation from strike price to current market value which may incentivize executing this strategy. Again, there must be adequate cash in our brokerage account to initiate the mid-contract unwind exit strategy.
When stock price increases the cost to close puts decreases
Negative Deltas force put values lower as share price accelerates. Short put positions can be closed at a lower cost than the premium initially generated. This is the basis for our 20%/10% guidelines for selling cash-secured puts. When share value rises, the cost-to-close short puts is less than that for selling short calls.
Cost-to-close summary chart
Cost–to-Close Short Options
Discussion
Whether using covered call writing or selling cash-secured puts, a cash reserve of 2% – 4% is required for possible exit strategy opportunities. When share value declines, the cost to close short calls decreases whereas the cost to close short puts increases. When share value rises, the cost to close short calls rises and falls for short puts.
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Upcoming live events
December 6, 2016
Options Industry Council Webinar Summit
Tuesday afternoon…1:30 PM ET:
Those who register but cannot make the live event will be sent a link to the presentation recording.
February 27, 2017
Stock Trader’s Expo
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 consolidated recent gains this week, while interest rates and oil prices both rose. An OPEC production cut was announced on Wednesday, helping push the price of West Texas Intermediate crude up to $51 a barrel from $47.50 a week ago. Volatility, as measured by the Chicago Board Options Exchange Volatility Index (VIX) moved up to 14.12 from 12.6 last week. This week’s reports and international news of importance:
- The US economy added 178,000 new jobs in November, in line with market expectations
- The unemployment rate dropped to 4.6%, the lowest in nearly a decade
- Average hourly earnings were disappointing, dropping 0.1% in November after rising 0.4% in October. Economists had expected earnings to rise 0.2%
- GDP was revised up for the 3rd quarter to an annual rate of 3.2%
- After-tax corporate profits advanced a robust 5.2%, the first rise since late 2014
- Solid recent economic data, combined with reflation hopes in the wake of the US election, have pushed US yields significantly higher in the past several weeks. To illustrate the point, the Bloomberg Barclays Global Aggregate Bond Index suffered the worst monthly loss in its history in November, declining 4%
- Manufacturing purchasing managers’ indices have been showing a broad global turn for the better in recent months. November data showed sizable gains, with PMIs in the US, China and the eurozone all exceeding forecasts. The Institute for Supply Management’s US manufacturing PMI was particularly robust, rising to 53.2 from 51.9. A reading above 50 signals that the sector is expanding
- A referendum on constitutional reform takes place in Italy this Sunday. Prime Minister Matteo Renzi has vowed to resign if the referendum goes down to defeat. Polling ahead of the vote suggests the referendum won’t pass, though there are still a large number of undecided voters. A defeat would add momentum to the anti-establishment mood among voters in both the US and Europe
- Austrians return to the polls on Sunday to vote in a long-delayed presidential election between Alexander Van der Bellen, a Green who is running as an independent, and Norbert Hofer of the populist People’s Party. Van der Bellen won a close contest in May, but voting irregularities forced Sunday’s rerun. The stability of the European Union could be called into question if anti-establishment momentum continues to build ahead of key federal elections in the Netherlands, France and Germany in 2017
- Thursday, French president François Hollande, whose approval rating stands at just 4%, announced that he will not stand for reelection next year, becoming the first French president since World War II not to seek a second term
- OPEC leaders met this week in Vienna and agreed to cut production by OPEC members by 1.2 million barrels per day and by 600,000 barrels per day by non-members, including Russia. The deal is the first of its kind in eight years. OPEC hopes the agreement will result in a reduction in inventories over the coming months, which they hope will coincide with a pickup in demand
- President-elect Donald Trump announced he will nominate Steven Mnuchin as Treasury Secretary. Mnuchin is a former Goldman Sachs executive and hedge fund manager. Tax reform and reducing regulation are high on Mnuchin’s agenda
- Trump also nominated financier Wilbur Ross to serve as Commerce Secretary. Ross said increasing US exports will be his focus, along with negotiating favorable bilateral trade deals
- Economic growth in Europe looks to be gathering momentum as unemployment in the eurozone fell below 10% this week for the first time in seven years this week, to 9.8%
- In addition to a firm PMI, Germany reported the largest jump in retail sales in five years. Sales rose 2.4% in October compared with September
- The Case-Shiller National Home Price index this week eclipsed the peak it set in July 2006. From that peak to its 2012 trough, the index fell 27.4%. However, the recovery has been uneven across the US, analysts say, and point to median home prices still being about 20% below their 2006 peaks
- Facing massive protests as a result of a corruption scandal, South Korean president Park Geun-hye is under intense pressure to end her term early. On Tuesday, Park said she would resign if ordered to by the nation’s parliament
THE WEEK AHEAD
- Italy holds a constitutional reform referendum on Sunday, December 4th
- Austria holds presidential elections on Sunday, December 4th
- Service sector PMIs are released on Monday, December 5th
- The United Kingdom releases Q3 GDP figures on Wednesday, December 7th
- Japan reports Q3 GDP on Wednesday, December 7th
- The European Central Bank Governing Council meets to set rates on Thursday, December 8th
For the week, the S&P 500 declined by 1.00% for a year-to-date return of +7.20%.
Summary
IBD: Uptrend under pressure
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. Like the rest of us, the market is still trying to figure out how new economic policies will impact corporate bottom lines. I tend to favor defensive postures in these environments and that’s why I only established 50% of my December contract positions with out-of-the-money strikes.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
The 6-month charts point to a neutral outlook. In the past six months the S&P 500 was up 5% while the VIX also rose by 5%.
_____________________________________________________
Wishing you the best in investing,
Alan ([email protected])
Do you have any writings on or thoughts on selling CSPs ATM on stocks using weeklies to get weekly income and assignment and then turn around and sell the stock’s next week’s CCs ATM to get weekly income and called-out and repeat the process week after week?
Scott,
I believe that we can be successful with most strategies if the implementation and management is done properly. I will offer some thoughts on this particular strategy for your consideration:
1- Weeklys offer some pros and cons when compared to Monthlys. Concerns would include lack of time to properly manage positions and quadruple the number and amount of commissions…there are more.
2- ATM put strikes may hurt us in bearish market environments. We may end purchasing stocks at a much higher price than current market value. OTM put strikes may be preferable especially in bear markets (I use only OTM put strikes).
3- ATM CCs could also hurt us in bear markets. The amount of share decline could far surpass the amount of premium we receive. ITM call strikes may be best in bear market scenarios.
In general, I like this strategy in bear market environments especially. I call this the PCP (Put-Call-Put) Strategy but I use Monthlys and OTM put strikes only and various call strikes depending on overall market assessment, chart technicals and personal risk tolerance.
For details and examples of how I use this approach, see pages 231 – 238 in my book “Selling Cash-Secured Puts”
Alan
Scott,
This is an interesting question. Is it a pure hypothetical or do you have some run time doing this? And if so, which stock(s) did you use and how has it worked? Thanks, – Jay
Hello Jay,
NVDA
I read your response to me on last week’s thread, and I really loved it.
I am keeping a copy of your explanation in my “investing rules” file.
As I told you before, I have nobody to share my trading experiences with here in Brazil, and therefore you and Alan are my closest trading friends.
Thank you again – Roni
Thanks for your always kind words Roni. The great part of our strategies is how flexible they are even though they seem so simple on the surface. Wishing you continued success with NVDA as far as you choose to trade it! – Jay
Roni,
Where can I see the response from Jay you’re talking about?
Is there a way to search using key words?
Alan,
Have you ever thought about setting up a BCI forum? This would make conversations easier as I see not all replies relate to your initial article.
Michael
Hi Michael,
you can see last thread “Earnings pre Announcements”
When you log in, scroll down all the way to “Latest Blog Articles”
Take care – Roni
Roni, thanks for your reply on Dec 5th. Don’t know why I could not post my reply right where your response was.
Jay,
This proposed strategy was also sent to me off-site as a hypothetical, untested strategy. I get a lot of these and really admire our members who think outside the box.
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 12/02/16.
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
Best,
Barry and the BCI Team
Hi Barry,
The watch list is very concentrated in banks and financial entities.
After the Trump election, and the FED intention to raise interes rates I believe this is a sound trend.
But I normally keep a very diversified portfolio, 8 or 10 positions in different industries and companies.
Therefore I am having a hard time to find covered calls alternatives for the January 20 contracts.
I know it is early, but maybe you can give me some hint for my search ?
Thanks – Roni
Hi Roni,
What we’re seeing is “sector rotation”. If you recall, a few months back we saw a lot of companies from the chip and semi-conductor industry sectors. With the expected rate increase that is rumored to be forthcoming from the US Federal Reserve Bank, it would be reasonable to expect financials to take the “lead”. By the way, we’re seeing the same thing in the ETF Report.
One thing that you might do is to take a look at both the other ETFs in the ETF Report as well as the stocks in the most recent Blue Chip Report. These reports are in the Premium Member section of the website.
Best,
Barry
Thank you Barry,
I do appreciate your help.
I have a lot to learn, and therefore I am focusing on trading exclusively 1 month buy/writes in stocks, with covered calls only.
I do not feel totally confident yet in my skills with these trades.
They seem very straghtforward, but they are not.
The devil is in the details.
My goal is to avarage 2%, but my mistakes are still too many.
I am watching carefully the ETF report each month, and also the new Blue Chip Report, but I am not yet ready to handle it all at the same time.(I do not have enough time).
Also, it seems to me that the premiums of ETFs and Blue chips are generally very low.
Thanks – Roni
Hey Roni,
Most people look at risk management horizontally across sectors which is logical. Another way to do it is vertically.
If we start with a financial stock on the watch list, lets say RF, it is only .64% of the XLF and has an over 30% Implied Volatility ATM. If uncomfortable with that one can move up to JPM on the Blue Chip List which has 10% makeup of XLF and a low 20’s IV. If not yet comfortable there one can move up to the XLF itself which has an IV in the high teens. If still antsy the SPY has an IV of 11% ATM.
The first question to ask is “Do I think the market will be higher at Jan expiry than it is now?” If yes sell OTM calls on up days on half your holdings and let the rest run. Sell OTM puts on down days on things you would like to own using sideline cash. If no do what Alan does and sell ITM calls but don’t buy anything new at these prices.
If bullish on SPY ask yourself which sectors are most likely to be up? Look at the top ten holdings in the XL SPDR for the sectors you like. If still confident dive deeper for the small caps in the sector.
If you get short of breath go back to the surface with SPY. Always ask yourself “Have I beaten SPY this year?”
That is the benchmark.
If so you did something right: keep doing it! If not the buy and hold guys beat us while fishing and playing golf :). We need to do something different! – Jay
Hi Jay
I used to do all kinds of sports when I was younger, but today my favorite passtime is trading American stocks.
But of course, it will be so much more fun if I get to beat the market consistently.
I am sure it will happen once I make less mistakes.
The number I watch every day is the account value.
When it grows every month I feel very good.
When it does not, I try to minimise losses.
Buy and hold is maybe the best, but I can’t sleep when a stock is crushed, and can’t sleep when a stock bounces, because I feel I should sell.
Also, I would not have fun fishing or golfing while my stocks are out there moving on every bit of news.
Thanks again – Roni
Alan,
Can’t believe I am so stupid as to only now realize why you buy covered stock rather than sell puts in a suspect market. Well rather than lament that I will just say again how much I value your wisdom. Without experts like you many of us would be at sea.
Thx,
Ron
Ron,
It’s really not a matter of one strategy being inherently better or worse but rather a requirement to fully understand the pros and cons of each and then managing accordingly.
For example, in a bear market environment, selling deep out-of-the-money puts to enter a covered call trade is a reasonable strategy approach (PCP strategy- pages 231 – 238 of “Selling Cash-Secured Puts”). On the other hand, we may opt to only sell deep in-the-money calls. Both approaches can result in successful trades as long as we set up and manage these trades based on sound fundamental, technical and common sense principles, non-emotionally.
Thanks for your kind words.
Alan
Alan,
I had a covered call exercised on Friday for a security that had a very small cost basis associated with it. It is now Monday and I’m wondering if buying back the shares today might avoid the large tax. I know that if I sell a stock at a loss then I can’t enjoy that loss if I buy back that security within 30 days, I’m wondering if that rule also applies to a gain.
Thank you,
Robert
Robert,
Since I am not a tax expert, I will offer my response with the understanding that you should confirm it with your tax advisor.
No, it is my understanding that buying new shares will not shield you from capital gains tax. However, if the shares were owned for more than 1 year and 1 day, the capital gains will be taxed at the lower long-term capital gains rate even if the option sale was recent.
If there are any CPAs in this forum who have other perspectives, we welcome your input.
Alan
Alan,
I’ve been following your weekly watch list now for a couple of months, with increasing scrutiny and regularity. However, I am really not sure how to use it effectively with regards to exiting positions, etc.
I’ve looked through your website for information, and your two encyclopedia books without much luck.
As an example, I entered a position in WB recently when it was on your list, which produced a profitable trade. However, I then missed the next watch list, and did not notice that it had been removed. My bad, of course. The stock then declined, although not below my break-even. I hung on, and it rebounded, salvaging my gains.
So, I guess what I am asking is, what is the plan for a position once it is removed from the list?
Thanks.
John
John,
In The Current Contract Month, a position is managed by the rules and guidelines of the BCI Exit Strategies and not by its removal from our watch list in the subsequent weeks of that same contract month. In a typical month, a stock may come off and back on the Running List.
We highlight this rule on page 3 of our stock reports as shown on page 3 of the premium stock reports and in the screenshot below.
Once a position is entered, use the information from our exit strategy chapters of my books and DVDs.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG
Alan
Thanks, Alan.
That is what I thought was the interpretation.
I’ve stayed with the position since 9/26, and have generated $7.17 in premiums. The current position, expiring 12/16 has a strike price of 48, a dollar below my cost of 49, but well above my break-even of just under 42. Market is currently pretty near the money, so I seem positioned OK for now? Producing about a 13% if it stays at or in the money.
Thanks for your help. This was my first trade from your list.
John
Hi Alan, I am just needing to ask 4 questions below for the moment, there’s another set coming next week that will then be my lot before the Xmas break:-
1. Should I sell my Stock/Etf if I see for my strike price that the option open-interest is falling, and spread getting larger too? (for instance the DEC-$38C for ‘SNV’ which I am using, – it’s well ITM at this stage anyway?)
2. Is there any point searching for a stock to trade for the start of the final contract week? (like if I had just done a DMCP for 1 or 2 stocks near the end of the 3rd week?)
3. Wondering how you would deem a breakout above a Resistance level? Could you go by the price needing to close above it for at least 2-3 days first, or maybe for the price to close above resistance by at least a certain percentage before it’s called a breakout, or perhaps some other reason you know of?
4. And in order to want to ‘hit a double’ then should it be required that the price always has to be in an Uptrend?
What if the price happened to be in a S/ways channel & so price falls down to the support level, because then the chart doesn’t look as positive as when it is above an Up-trendline, to go and hit a double?
I can report too that I have just hit a double on a papertrade, yet it was already in an uptrend at the time. But at least I think I am getting the hang of this strategy better over all the past months I have tried to apply it. Thanks
Adrian,
2- Usually not…I wait for the start of the next contract.
1- At this point you have maximized your return on this trade and have significant downside protection (nice going!). The published cost-to-close is $4.90 which include about $2.70 in time value…very expensive. We may be able to negotiate a better close price but it still will be expensive. I can’t give specific financial advice in this venue but I can tell you that I generally would take no action in similar scenarios.
I’ll get back to you on 3 and 4.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG
Alan
Adrian,
3- I deem a breakout above resistance most significant when it occurs on higher-than-average volume and when confirmed by other technical indicators.
4- It is possible to “hit-a-double” if a price is trending sideways within a price range. As long as the option premium meets the 20%/10% guidelines, we buy back the option, then re-sell if the price rises within that range…look for the classic V-Shaped pattern of price movement within that consolidating price range.
CONGRATS on hitting that double!!!
Alan
Options Industry Council Webinar Summit today:
I will be part of a panel discussion from 1:30 PM -2:30 PM ET.
Registration is free:
https://event.on24.com/eventRegistration/EventLobbyServlet?target=reg20.jsp&referrer=http%3A%2F%2Fwww.optionseducation.org%2Fseminars_events%2Fall_seminars%2Fwebinar-summit.html&eventid=1275040&sessionid=1&key=6E8D5F7A3A547F1E3EB77C7AAA813C76®Tag=&sourcepage=register
Alan
Alan,
Thank you for the clear explanations on option trading that you have provided us in your books and seminars. They have allowed us to quickly become successful in this practice. What are your thoughts on algorythem based automated trading systems?
Thanks,
Laszlo
Laszlo,
Algorithms can be useful in many situations but are only as good as the information they are based on. I know of none geared specifically to covered call writing or short-term put-selling. Even if such a program did exist, I’m certain most BCI members would out-perform it. There are covered call ETFs that generally under-perform the overall market and certainly the results achieved by our BCI community and many of these fund managers do have access to algorithms.
I am always open to enhancing the results and efficiency of our trading system but at this point automated trading systems are not the answer.
Alan
Running list stocks in the news: CFG
Banking stocks have had a great run since the election and with consensus favoring an interest rate hike this month. This is reflected in both our premium stock and ETF reports (new ETF report coming out this evening). Citizen’s Financial Group is one such banking stock currently in our premium stock report and has been so for the past 7 weeks (see the yellow highlighted field in the screenshot below).
CFG is a regional bank boasting recent double-digit earnings growth. It recently incorporated digital investing capabilities to its Wealth Management platform.
In its 3rd quarter earnings release, it beat earnings consensus by 3 cents and earnings growth is projected to be up 13.4% in 2017 compared to 2016.
Our Premium Stock Report shows CFG in the “Bank” industry currently ranked “A” It has a Scouter Rank of “9”, no Weekly options, adequate open interest for near-the-money strikes. a beta of 1.44, a % dividend yield of 1.40, a projected next earnings report on 1/20/2017, and a last ex-dividend date on 10/21/2016.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG
Alan
Premium members:
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.
For your convenience, here is the link to login to the premium site:
https://www.thebluecollarinvestor.com/member/login.php
NOT A PREMIUM MEMBER? Check out this link:
https://www.thebluecollarinvestor.com/membership.shtml
Alan and the BCI team
Options Industry Council’s webinar summit:
To hear a replay of my panel discussion event yesterday with 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. To listen to only me (or only the other speakers!), I go on:
35:20 – 58:00 and
69:07 – 69:55
Presentation slides correspond to the audio
Hope you enjoy it.
Alan
Alan,
I bought 100 shares of TRV @ 110.54 & I sold a call Jan ’17 115 @ 1.26
TRV is trading @119.99 & the call is @ 4.35
When it comes to expiration date the stock is taken from me @ 115 & I kept the 1.26?
Thank you for your help
Alan
Alan,
Yes you are 100% correct assuming the following:
1- You take no action to avoid exercise (buy back the option)
2- The stock is trading above $115 at expiration
If this scenario plays out, you will have the premium + share appreciation and a resulting 5.2% return on this investment…congrats!
An important exit strategy to watch for if time value approaches zero is the mid-contract unwind exit strategy (MCU) which I wrote about here:
https://www.thebluecollarinvestor.com/mid-contract-unwind-exit-strategy-a-real-life-example/
You may be able to generate even higher returns.
There are more details and examples in both versions of the Complete Encyclopedias.
Keep up the good work.
Alan
Alan,
One question I have is regarding the bid ask spread strategy. When you submit a trade to sell an option between the bid and ask, do you have to wait until the broker accepts the trade? Is there a time lag?
Thanks,
Richie
Richie,
Once we enter the trade, we will see one of two things in a matter of seconds:
1- Our trade will be executed at the limit order price or better
2- We will see the published bid-ask spread adjusted (decreased) to reflect our limit order
If we do not get executed, we can try again with a new limit order between the bid and ask, always slightly favoring the market-maker.
Alan
Alan,
When you recommend a portfolio of 1/2 ITM and 1/2 OTM, what is your process in selecting which stocks you should go ITM and which stocks you go OTM?
Kind regards,
Alex
Alex,
I tend to favor OTM strikes for stocks with the strongest technical chart patterns. In our premium stock reports, they would be the stocks listed in “bold” lettering.
Also, if I am using multiple contracts per position I will divide between ITM and OTM such that my entire portfolio represents. half of each.
Alan