Successful covered call writing requires discipline and appropriate analysis specific for this great strategy. In the Blue Collar Investor (BCI) methodology we incorporate three major screening components before we even look at options chains:
- Fundamental analysis
- Technical analysis
- Common sense principles
The details of the entire screening process are discussed in my books and DVDs and in today’s article we are going to focus in on one critical aspect of the fundamental component and one from the technical component. The fundamental screens used in the BCI methodology include two from Investor’s Business Daily and one from Money Central’s Scouter Screen. These are the first screens we run our securities through and then move on to the other technical and common sense screens. One of the most important statistics as they relate to fundamental analysis is related to earnings growth. Companies that show strong stats in this areas will become “darlings” for the institutional investors, the folks who move the market. The most pertinent screen in this regard in the IBD Smart Select Ratings screen (predominantly fundamental in nature with a technical component). Two of the parameters measured in this screen are EPS rating and RS Rating, the latter a technical screen.
EPS Rating: This compares a company’s earnings per share growth on both a current and annual basis with all other publicly traded companies in the IBD database. In the BCI methodology we require all of our eligible covered call writing candidates to be in the top 20% of all considered securities. This ensures that our choices have both short-term and long-term strength as it relates to earnings growth.
RS Rating: This screen measures a stock’s price performance over the past 12 months compared to all other equities in the database. Here again, we require all of our “eligible” stocks to be in the top 20%.
Now this brings me to an interesting chart which was published in a recent issue of Investor’s Business Daily. It is called the IBD Weekly Review 85-85 Index. The two key requirements for a stock to be included in this index are Earnings Per Share and Relative Price Strength Ratings of 85 or higher, nearly mirroring the requirements of the BCI methodology. Here is a screen shot of that chart:
Earnings and Price Strength Analysis
Although this index does not precisely mirror that of the BCI methodology, it comes quite close and the results over the 12-year period is quite impressive. The point to consider is that using BOTH fundamental and technical analysis will enhance our opportunity for achieving maximum profits when writing calls on these equities. In our BCI screens we use so much more than the two I am highlighting in today’s article. It is important to achieve a balance between maximizing our opportunities to achieve the highest possible returns and analysis paralysis. In our BCI methodology we use very specific screens with consistent technical analysis parameters and then add in our extremely important common sense parameters (avoiding earnings reports and much more).
For our new members the process may seem a bit complicated at first but like learning how to use a computer after a while it becomes second nature as well as user and time friendly. Our BCI team does the ENTIRE screening process for our premium members but this is certainly something you can do yourself if time is not an issue and if you are so inclined. The important takeaway from this article is that the screening process MUST include all three screening components before investigating an options chain:
- Fundamental analysis
- Technical analysis
- Common sense principles
If we only consider securities that meet all of our strict BCI requirements as “eligible” for covered call writing candidates our opportunity to achieve maximum returns will be enhanced exponentially.
Florida seminar:
Thanks to all BCI members who attended my recent presentation in Coral Springs Florida. Besides escaping from the brutal NY weather, it was a pleasure getting to meet you in person. My next seminar will be in Atlanta in April.
Market tone:
The Federal Reserve officials appeared relatively optimistic this past week as it stated that “moderate economic growth” has returned. This was backed by the week’s economic reports:
- The Fed will keep its target rate for short-term interest rates between 0% and 0.25% as long as unemployment remained above 6.5% and inflation below 2.5%.
- The Fed will continue to buy $40 billion worth of agency mortgage-backed securities and $45 billion worth of US Treasuries per month. This will keep long-term interest rates low and borrowing more affordable
- New home construction was strong in February with 917,000 new homes started, 0.8% higher than the upwardly revised January statistic and above expectations
- The rate of new residential construction is up 27.7% from a year ago
- Existing home sales rose 0.8% in February, 10.2% higher than February, 2012. This was the 20th straight month that sales exceeded the year-ago level
- The Conference Board index of leading economic indicators rose 0.5% in February, above expectations and January results were revised upward. This index has gone up in three straight months and five of the past six. It is important to consider that these stats do not take into consideration the impact that sequestration (budget cuts to federal spending that started on March 1st) may have and that is why my outlook may appear a bit muted despite the favorable reports
- Initial jobless claims for the week ending March 16th came in at 336,000, less than the 345,000 anticipated
For the week, the S&P 500 declined by 0.2% for a year-to-date return of 10%, including dividends.
Summary:
IBD: Confirmed uptrend
BCI: Moderately bullish but still favoring in-the-money strikes until the impact of sequestration can be measured
Wishing you the best in investing,
Alan
Mid-contract unwind: Offsite Q&A
Alan,
I bought SLCA at $22, now is at $23.52 with a gain of $456
I wrote a covered call on SLCA at $22.50 @ $1.20
Should I buy back my call @ $1.75 and sell my stock instead?
So that I can re-invest my money?
Hi Colin,
I hope you understand that I cannot give specific financial advice in this venue but I can make a few observations that you should find useful. First, let me congratulate you on a fabulous trade…a 7.7% return in a few weeks. Now the question is should you close your position now that you’ve maxed your profits? Take a look at the screenshot below:
It will cost you $1.90 to close the short option position. Of that, $1.26 is intrinsic value or money you will get back due to share appreciation above the strike price. That leaves a debit of $0.64 or 2.9% of your initial investment. The question is can you generate more than 2.9% in the remainder of this contract cycle to make the effort worth your while.
In the BCI methodology we unwind our entire position mid-contract after a trade is maxed out when the time value approaches zero and there is an opportunity to generate a much higher return than the debit incurred. If not, hold the position as the 7.7% now has significant downside protection. CLICK ON IMAGE TO ENLARGE AND USE THE BACK ARROW TO RETURN TIO THIS BLOG:
Alan
Premium Members,
The Weekly Report for 03-22-13 has been uploaded to the Premium Member website and is available for download.
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 BCI YouTube Channel link is:
http://www.youtube.com/user/BlueCollarInvestor
Best,
Barry and The BCI Team
Alan,
Can you provide the link to get to the Scouter screen you mention in this article.
Thank you,
Ruth
Ruth,
Here is the link…just put in stock ticker:
http://money.msn.com/investing/stockscouter-stock-ratings.aspx
Alan
Hi Alan,
Off topic, but I’m wondering if you’ve written anything about this “trader’s tax” supposedly going into effect over in some Euro-Countries as soon as 2014 (and which may come to the US, compliments of a couple reps introducing a similar bill here).
It seems that it will, if passed anywhere near it’s current form, greatly affect those of us that do any serious amount of trading, especially via the use of options (since the tax will be based not on the option value, but of the total value of the underlying the options represent).
OR…do you think it is too soon to even begin thinking about this? I’m just frustrated, as it has taken me about 20 years to develop a trading methodology that works for me and this tax is really going to throw a monkey wrench in it.
-Doug
Response from Owen Sargent, CPA:
Unlikely.
It is very speculative that anything like it would pass in the US.
It is unlikely that it would apply to all transactions., if it did.
Since most markets are electronic, any tax would be hit hard by moving the bulk of the transactions to another market.
It is more likely that it would apply to high speed, high volume transactions, less as a money raiser than as a high speed trading deterrent.
Keep your Congressional representatives names and addresses handy. If it starts to take shape, let them know you will remember when you vote.
Running list stocks in the news: ASGN:
With the jobs market (slowly) improving, staffing companies like On Assignment are benefitting. The US economy added 236,000 jobs in February and the Commercial Services-Staffing Group is at a 5-year high. Then price of ASGN is near an 11-year high.Our Premium Running List shows an industry rank of “A” and a beta of 1.98. As a result earnings eastimates have been climbing as shown in the screen shot below (CLICK ON IMAGE TO ENLARGE AND USE THE BACK ARROW TO RETURN TO THIS BLOG):
Alan,
Earnings Whipers says unconfirmed date of ASGN ER is 4/25 (after close), a week after the April 20 expiry. A few months ago, I had a call set to expire a few days before ER, and news of the gist of the report, coincident withe expiry date, ‘leaked’, and made it so I might as well have written contract though earnings season. In your experience, is that a common problem to weigh when considering CC on one like ASGN under the current circumstances of an ER close to expiry. Like the stock, just wondering how close to our non-negotiable parameters this is. Thanks for the information, and for you and your team’s great work for the BC community. Nelson
Nelson,
You bring out a good point: there are times when unexpected news, good or bad, can come out regarding our underlying security. The BCI methodology takes every possible precaution to avoid risk but unexpected bad news cannot be predicted. To counteract an unexpected drop in price we have our exit strategies in place or we can buy protective puts as an insurance policy when entering our positions. I do not do this but some of our more conservative members do. The downside: lower returns.
Thanks for your generous remarks.
Alan