Covered call writing and selling cash-secured puts are low-risk option-selling strategies seeking to generate weekly or monthly cash-flow. Can these basic strategies be considered exit strategies as well? In this article, I will make the case that, yes, they can be considered both.
When is covered call writing an exit strategy?
After selling a cash-secured put, if the strike is expiring ITM, one of our exit strategy choices is to allow exercise and take possession of the shares with the intent to then write a covered call.
When is selling cash-secured puts an exit strategy?
After selling a covered call, if the strike is expiring ITM, one of our exit strategy choices is to allow exercise resulting in sale of our shares and then using the cash to secure a put sale.
The Put-Call-Put (PCP) Strategy (also called the wheel strategy outside the BCI community): Graphic representation
PCP Strategy
Real-life example with TMUS (taken from Chapter 27 of my new book, The Blue Collar Investor’s Guide to: Exit Strategies for Covered Call Writing and Selling Cash-Secured Puts
- 4/7/2020: TMUS is trading at $86.09
- 4/7/2020: STO 1 x 5/15/2020 $82.50 OTM put at $2.91
- 5/15/2020: The $82.50 put expires ITM and shares are put to us at $82.50 (less the $2.91 put premium for a breakeven price point of $79.59
- 5/18/2020: Consider the 6/19/2020 OTM $82.50 call strike
- 5/18/2020: Consider the 6/19/2020 ITM $77.50 call strike
Initial put trade returns
TMUS: Initial Put Trade Results
Using the BCI one-of-a-kind Trade Management Calculator (TMC), we see that the initial return on the put option sale is 3.66%, 34.22% annualized based on a 39-day trade. Shares are put to us if the strike moves ITM at expiration and we take no action to close the ITM short put. TMUS is purchased at a breakeven price point of $79.59 or a 7.55% discount from the share price when the put sale was initiated.
Initial covered call trade returns if shares are put to us at $79.59
TMUS: Call Leg Opportunities
The OTM (from the perspective of the breakeven price point of $79.59) $82.50 call strike (red arrows) shows an initial time-value return of 2.89%, 31.96% annualized based on a 33-day trade. There is also an upside potential of an additional 3.66% if share value moves up to or beyond the $82.50 OTM strike. The breakeven price point is $77.29.
The ITM $77.50 call strike (blue arrows) shows an initial return of 2.79%, 30.83% annualized based on a 33-day trade. There is also downside protection of the initial time-value profit of 2.63%. This means that if share value declines by 2.63% or less, we are guaranteed that the initial 2.89% time-value profit will be realized.
Discussion
Covered call writing and selling cash-secured puts are low-risk option-selling strategies. They can also serve as exit strategies for each other. The goal of the PCP strategy is to generate cash-flow. Each leg of the trade will accomplish either premium returns or purchasing a stock at a discount. Since there is a breakeven price point associated with each leg of the trade, there is risk that share value can decline below that price and we can start to lose money. We must always be prepared with our exit strategy arsenal to mitigate losses, enhance gains and turn losses into gains.
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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:
Alan,
I’ve been meaning to send you a short note. While I’m still studying the books and tools (I have purchased most of your books already), I think they are exactly what I was hoping to find. I’ve been selling calls for about a year before I found you on YouTube. During the year, I was looking for a better set of trading rules AND looking for help with how to account for the P/L. All the time I was learning, I knew I should be accounting for the profit or loss of the underlying. So, I was always sketching notes on these two topics. Now, I’ve found someone that’s been able to write on these subjects so I’m learning more useful ways to buy/sell options. So far, I’m very impressed with the books and vids.
Thank you so much for your great contribution to this area of finance.
John
Upcoming event
Money Show Orlando live event
October 30th – November 1st, 2022
OMNI ORLANDO RESORT AT CHAMPIONSGATE
Visit Alan, Barry and members of the BCI team at Booth # 415
Sunday, October 30, 2022, at 5:00 pm – 5:45 pm EDT
Covered Call Writing: Multiple Applications Based on Current Market Conditions
Monday, October 31, 2022, at 4:30 pm – 6:30 pm EDT
Selling Cash-Secured Puts: Detailed Start-to-Finish Six-Part Program*
Masters Class
Comprehensive Course on Selling Cash-Secured Puts
Detailed start-to-finish 6-part program
This presentation will provide all the information, with real-life examples, necessary to master the strategy of selling cash-secured puts. The program is divided into 6 sections:
- Section I:
- Option basics
- Section II
- Traditional put-selling
- Section III
- PCP (wheel) strategy
- Section IV
- Buy a stock at a discount instead of a limit order
- Section V
- Ultra-low-risk put/Delta strategy
- Section VI
- Ultra-low-risk put/Implied volatility strategy
This presentation was developed to benefit both beginner and experienced option traders and will provide all the information needed to initiate the strategy and elevate returns to the highest possible levels.
45-minute presentation
Covered Call Writing: Multiple Applications Based on Current Market Conditions
Real-life examples with Invesco QQQ Trust (Nasdaq: QQQ)
Covered call writing is a low-risk option-selling strategy geared to generating cash flow with capital preservation a key requirement. This presentation will demonstrate how the strategy can be crafted to benefit in all market environments. Market situations highlighted are:
- Normal to bull markets
- Bear and volatile markets
- Low interest-rate environments
A popular large-cap technology exchange-traded fund, Invesco QQQ Trust, will be used to establish rules and guidelines to benefit in these market circumstances.
Registration link and more details to follow.
***********************************************************************************************************************
Market tone data is now located on page 1 of our premium member stock reports and page 1 of our mid-week ETF reports.
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Good morning Alan,
I was thinking about this sentence : “As a reasonable example, one would have to invest $200,000.00 to generate $1000.00 per-week.”
Are you referring to $200,000 has cash or has a buying power? If it’s buying power and my broker offers 2 for 1, then I “only” need $100,000 in cash instead of $200,000.
Regards,
Alexandre
Alexandre,
I made this comment based on the following:
1. It is from an options-only perspective. The stock side may result in higher or lower returns.
2. It is based on reasonable option returns of 1/2% per-week.
3. If employing margin, interest rates will need to be deducted.
4. ***In my humble opinion, most retail investors should avoid margin accounts. There are exceptions for sophisticated, experienced investors.
5. Bottom line: Yes, buying power which, for most retail investors, should be cash available.
Alan
Hi Alan,
Hope you are well.
I purchased your new Exit Strategies e-book and loved it. I think it takes out all guesswork and emotions from trading options. And while I am relatively new to this, I can see how some mistakes I have already made would have been prevented if I knew about these before.
I had a couple of questions, I was hoping you could answer. They are both related to the relationship between a cash secured put and in-the-money covered call?
1. Is there any difference between selling a CSP and buying stock and selling a call option for the same In-the-money strike? Both will give us the same down protection and similar time value premium.
2. Hitting a double: If the price of the underlying stock declines mid-contract, we can use the hitting a double exit strategy for our ITM CC. But there is no similar strategy with a CSP. All we can do is roll down or exit the trade (3% guideline) and sell a new position in a new stock. Am I right?
Thanks in advance!
Regards,
Swag
Swag,
Thank you for your generous comments about my new book.
My responses:
1. Yes, selling ITM calls and OTM puts with the same time-value premium are similar strategies with similar results. The reason some investors favor CSPs is that they don’t want to take possession of the shares but are willing to undertake the risk of possible assignment in return for the cash premiums.
One of the main benefits of covered call writing in normal to bull markets is when we can use OTM calls and set up trades with 2 potential income streams (option premium + share appreciation from current market value up to the OTM call strike). When selling ITM calls, that advantage does not exist.
The 2 strategies can be combined (the PCP strategy) where OTM puts are sold and, if exercised, ITM or OTM calls can be written.
Both are wonderful, low-risk cash-generating strategies. I favor CSPs in bear and volatile markets and covered calls in normal to bull markets. Both work in all market conditions.
2. “Hitting a double” is a term I adopted when 2 income streams are generated in the same contract cycle with the same underlying security. It normally applies to covered call writing where we see the classic V-shaped chart pattern.
Technically, it can be applied to CSPs as well, if we close the short put and then sell another put on the same security if share price recovers. If not, we can use the freed-up cash (from closing the original put sale), to secure another put with a different underlying security. In both cases, the exit strategy selected from the dropdown in the spreadsheet is “Close ITM strike & exit”
***If you are using our Trade Management Calculator and implementing multiple exit strategies with the same (or different) underlying in the same contract cycle, make sure you take advantage of the “capital adjustment” section to ensure the accuracy of our calculations.
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 08/4/22.
Due to family vacations, the data in the report was calculated as of market close on Thursday August 4th. The market tone has been updated through Friday August 5th and will be sent as a separate attachment. This approach allowed us to get the report published on Saturday rather than late Monday evening.
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Best,
Alan, Barry and The Blue Collar Investor Team
barry@thebluecollarinvestor.com
Alan,
After more than a two months pause, I started to invest again last week. I placed 3 very conservative 08/19 CC trades, totaling 20% of my trading cash.
It seems that the market has stabilized despite the strong headwinds of inflation, the Ukraine war, interest rate hikes, housing sales slump, supply chain issues, and recession fears, all still active.
The positive jobs report, earnings reports, and the lack of alternatives are certainly mitigating investors’ moods.
Anyway, the BCI methodology should keep us safe.
Roni
Welcome back, Roni. Good to hear from you.
Alan
Question for ALAN-
You mentioned to stay away from selling calling in a month that the stock reports earnings. What if you already own the stock? Do you just recommend not selling a call that month, or do you advocate selling to stock also?
Thanks in advance for your reply!
Bill
Bill,
If the stock is one that you wish to retain in your long-term buy-and-hold portfolio, we refer to that as “portfolio overwriting”, one of our covered call writing-like strategies.
We write only deep OTM calls with lower initial time-value return goal ranges.
If this is the case, we do retain the shares through an earnings report and write the call after the report passes.
If the stock is associated with weekly options, during the contract month of the ER, we write weeklys and skip the week of the ER.
If the stock is one that we are not committed to for the long term, we typically remove the stock from our portfolio and avoid the risk of a disappointing ER. It will then become potentially eligible after the report passes.
Alan
Alan- Thank you SO MUCH for your prompt and very helpful reply.
Best regards-
Bill
Alan,
What level (re broker) do you have to have to sell Cash Secured Puts ? I am only at level 2 and can only do Covered Calls (I THINK !!)
THANKS
Malcolm
Malcom,
The levels of option trading approval can vary from broker-to-broker. Some have covered call writing and cash-secured puts both in their lowest levels (“0” or “1”). Some have cash-secured puts in a higher level of approval.
I suggest calling your broker and speak to a rep explaining that you would like approval for cash-secured put selling. They will guide you from there.
Alan
Thanks Alan. Appreciated.
Malcolm
Alan,
Would the volatility of “earnings” work in one’s favor, if one traded a collar instead of a covered call; because of the Put’s downside protection?
Thanks,
Angelo
Angelo,
It is true that, by adding a protective put to our covered call trades, there will be mitigating protection against catastrophic share depreciation resulting from a disappointing earnings report. Of course, that protection will cost us money. If we insisted on writing a call through an ER, a collar would make sense.
If we avoided the earnings report and used a different security that is not reporting in that contract cycle, a protective put would not be essential, and we would be avoiding a potentially risky event. I recognize the fact that some investors prefer protective puts with or without the earnings factor and that’s okay if it aligns with their trading style and personal risk tolerance.
In the BCI methodology, we take the path that gives us the greatest potential to succeed with the highest portfolio returns. This means 1 of 2 approaches:
1. Avoid the security about to report and consider it after the report passes.
2. Hold the stock through the report and write the call after the report passes. The rationale for this latter pathway is that over the past decade, there have been many more “beats” than “disappointments”
Generally, we favor #1.
Alan
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