Two of the cornerstones of the BCI methodology for covered call writing involves selling options with 1-month expirations and avoiding earnings reports. Several of our astute members have inquired about selling 2-month options instead. The rationale is that all stocks and ETFs have options for the current and next month. The months farther out will vary depending on the cycle that the security was randomly assigned. The proposed strategy is set up as follows:
After an earnings report passes, we can sell a 2-month option on that stock and therefore require less management time and commissions. Once the report passes, if we still like the stock, we then sell another 2-month expiration and so our portfolio turnover will decrease. At first glance this appears to be a reasonable approach that should be investigated.
No one can dispute that commissions will be lower probably cut in half. But if we use an online discount broker, these fees will be negligible especially if we are trading multiple contracts per security. Position management will be the same with the exception that rolling an option will not be necessary should the strike be in-the-money after the 1st month. So far, all other factors being equal, the strategy appears to be viable. However, let’s not forget the most important aspect of covered call writing and that is generating the levels of option premiums and profit and maintain our low-risk posture. In this article I have selected a stock from our Premium Watch List, Opentable Inc. (OPEN), and will evaluate the one and two month returns. I am writing this article on November 18th, the start of the December, 2013 contracts. Here is the options chain for the 1-month December expirations:
With the stock trading @ $86.16, the out-of-the-money 1-month $87.50 call options are trading @ $3.
Next, let’s view the January, 2-month options chain:
The 2-month January, 2014 $87.50 out-of-the-money call options generate $4.50.
To compare “apples to apples” we must annualize these returns and then compare.
December, 1-month options annualized:
$300/$8616 = 3.48% = 41.8% annualized
January, 2-month options annualized:
($450/2)/$8616 = 2.6% = 31.3% annualized
The annualized returns are 10% greater for the 1-month expirations than for the 2-month expirations.
2-month expirations will reduce trading commissions and portfolio turnover. However, these benefits will dwarf in comparison to the financial benefit of selling 1-month options.
Next live seminar:
My team and I are currently in Las Vegas presenting a seminar and doing live interviews for The Money Show. Our next presentation:
January 14, 2014
Details to follow.
There was no news in this week’s reports to change this site’s positive view of overall market conditions:
- Minutes from the recent FOMC meeting reflected an overall assessment of an economy that continues to expand at a moderate pace
- The minutes also demonstrated concerns with high unemployment
- The market reacted slightly to the Fed’s stating that unwinding of the $85 billion in bond purchases may start “in coming months”
- The CPI (measures cost of living) decreased by 0.1% in October, the first decline in 6 months
- The PPI (measures US wholesale prices) declined by 0.2% in October, the 2nd decline in 2 months. Much of this decrease was related to declining gas prices
- Business inventories rose by 0.6% in September, a bullish economic signal
- Retail sales rose by 0.4% in October, the largest rise since July
- Auto sales and parts increased by 1.3%
- Existing home sales decreased by 3.2% in October due to rising mortgage rates
- The median price of existing homes rose slightly to $199,500
For the week, the S&P 500 rose by 0.4%, for a year-to-date return of 29%, including dividends.
IBD: Confirmed uptrend
BCI: Moderately bullish favoring out-of-the-money strikes 2-to-1
Wishing you the best in investing,