Covered call writing strike selection will vary from investor-to-investor. There is no single parameter that will guide us to the most appropriate strikes for our portfolios. Factors that must be considered are personal risk-tolerance, initial time-value return goal range and overall market assessment.
The type of underlying securities we use and the “moneyness” of the strikes play a major role after determining the degree of risk we are willing to accept. Those with extremely low risk-tolerance will favor low implied volatility stocks and ETFs and in-the-money (ITM) strikes. More aggressive investors will incorporate higher IV securities and add in out-of-the-money (OTM) strikes.
Initial time-value return goal range
The higher the potential returns, the greater the risk. We must establish this range prior to entering any of our option-selling trades. My preference is to have an initial time-value return between 2% and 4% for monthly contracts. This is the range I will use for this article.
Overall market assessment
- Bear markets: Favor ITM strikes which offer greater protection to the downside.
- Neutral markets: Favor near-the-money strikes which generate the highest initial time-value returns with little or no downside protection of that time value profit or upside potential.
- Bull markets: Favor OTM strikes which offer 2 potential income streams, one from option premium and the other from share appreciation up to the strike price.
CROX option-chain with CROX trading at $153.66 on 10-22-2021 (29-day return)
- Yellow: $145.00 strike (ITM)
- Brown: $155.00 strike (near-the-money or slightly OTM)
- Green: $160.00 strike (OTM)
CROX calculations with the BCI Elite Calculator
- Yellow: Initial return on option (meets our 2% – 4% criteria)
- Brown: Upside potential (share appreciation potential in bull markets)
- Green: Downside protection of the initial time-value profit (intrinsic-value protects time-value in bear markets for additional protection to the downside)
Strike selection is as much an art as it is a science. We must first establish our initial time-value return goal range. From there, we factor in personal risk-tolerance and overall market assessment. With these factors considered, strike selection will result in a well-thought-out plan.
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:
I bought your book to learn how to handle deep in the money calls in order to avoid giving the underlying stock to the buyer. I want to thank you because your book is helping me in this difficult task.
Thank you for your beautiful work on education you’re carrying out!
1. Wealth365 Summit: Free Zoom presentation
Thursday April 7, 2022
11 AM – 12 PM ET
An Ultra-Low-Risk Approach to Selling Cash-Secured Puts
Entering and Managing 10-Delta Trades
Selling cash-secured puts is a low-risk option-selling strategy seeking
to generate cash-flow with capital preservation in mind. This
presentation will highlight an ultra-low-risk path to option-selling
using Delta stats as a basis for the methodology. A new one-of-a-kind
trade management tool will also be introduced that will assist in
entering managing and receiving final trade results from start-to-
finish for both covered call writing and selling cash-secured puts.
Topics detailed in the course:
- Option basics
- Hypothetical and real-life traditional cash-secured put trades
- Pros & cons of selling cash-secured puts
- The 3-required skills for elite option-selling results
- Delta defined and implemented
- Real-life monthly cash-secured put trade with 6 income streams
- BCI Trade Management System (first-ever such tool)
2.Long Island Stock Investors Meetup Group
Stock Options: How to Use Implied Volatility to Determine Strike Selection
Creating 84% probability successful trades for covered call writing and selling cash-secured puts
Wednesday April 13, 2022
7:30 PM ET – 9:30 PM ET
3. LIVE at The Money Show Las Vegas
May 10th – 11th
Portfolio Overwriting (free)
Tuesday May 10th at 1:30 PM – 2:15 PM
Increasing Profits in Our Buy-And-Hold Portfolios Using Covered Call Writing
A Comprehensive Analysis of Covered Call Writing: 2-hour Masters Class (paid event to The Money Show)
Wednesday May 11th at 1:30 PM – 3:30 PM
How to master all aspects of this low-risk option-selling strategy
Market tone data is now located on page 1 of our premium member stock reports and page 1 of our mid-week ETF reports.
So sell OTM put with a very low delta and gamma on stocks with low quotation (for example <20USD) , should be a low risk strategy for retired!
While sell OTM call on a good portfolio is another?
Is this right?
Selling OTM puts with a low Deltas is considered a lower-risk or defensive approach to option-selling. The price of the underlying stock is relevant only in terms of the total capital at risk but, if enough capital is available, we should not only favor stocks priced < $20.00. It would greatly limit the pool of stocks we are considering. For covered call writing, selling ITM calls is a more defensive approach because the intrinsic-value component of the option premiums gives us greater protection to the downside. We should only consider elite-performing stocks and ETFs whether we are taking defensive of more aggressive approaches to these strategies. Bottom line: For lower-risk approaches to option selling, use deep OTM puts and ITM calls. Alan
I have my Apr batch of covered calls simmering…
So, I’m focused on the exit strategies.
I understand if the stock goes down and the option price declines the 20/10 rule may come into play and I understand how to deal with that.
I also understand that for a stock that has an “exponential appreciation” that using the Unwind Now calculations is the way to go.
In your PRGO example in the book, it had an 11.1% appreciation.
So, first question – is there a percent appreciation that triggers your decision to unwind now, or is there a range where you may start the calculation process in preparation for taking action should the stock continue to rise?
Second question – is the Unwind Now exit strategy appropriate for the entire 4/5 week period or just early in the contract?
I also understand that due to the rise, it’s probably best to consider selling ITM calls after closing the BTC the original calls as profit taking may occur due to the run up.
Thanks in advance.
1. If share price rises significantly and the time-value component of the premium approaches zero, we consider the mid-contract unwind (MCU) exit strategy. The guideline to use:
If we can generate at least 1% more than the time-value cost-to-close by the end of that same contract, we consider implementing the MCU exit strategy.
2. Because of Theta (time-value erosion), the opportunities for MCU will mostly be in the first half of a monthly contract but there are exceptions especially in volatile market conditions. Here is a link to an article I published related to this topic:
Alan and Frank,
I love MCUs, and my approach is the same as the 20%/10% guideline for buy-backs.
If I can make 80% of my initially expected return in the first half of the options cycle, I will unwind. I feel very satisfied with the resulting annual return.
If I can make 90% in the second half, I prefer to Unwind because there is always the risk of a reversal in the stock’s price in this volatile market.
This is a question about how the initial return is calculated on a CSP.
If the stock is @ $110, and you sell a OTM put strike $90 for $2 premium, is the return when you enter the trade calculated as…
%return = $2 / $90
OR is it….
%return = $2 / ($90-$2)
I believe you use the latter calculation and if so can you please explain as I don’t understand why the premium is subtracted from the strike.
Thanks in advance for clarifying!
The initial return is $2.00/ ($90.00 – $2.00).
The reason is that the cash required by our brokers to “secure” that put sale is [(put strike – put premium) x 100 x # contracts sold].
This is our cost-basis or investment. In this hypothetical, the initial return for 1 contract is:
$200.00/ [($90.00 – $2.00) x 100 x 1 = 2.27%
The percentage will be the same no matter how many contracts we sell.
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 03/25/22.
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:
Barry and The Blue Collar Investor Team
Alan and Barry,
On Monday and Tuesday, I entered all my 04/14 CC trades, all selected from the stock screen. It was not easy to find ITM strikes with at least 2% ROO, and therefore I chose mostly OTM trades. All BTC orders are in place, but if any ticker goes too far south, I will run earlier.
I am now 97% invested.
If we have a dual goal of a monthly initial time-value return goal of at least 2% + a defensive posture to our trades, we can also check the option-chains for OTM put returns.
Thank you for reminding me about the OTM put alternative.
I have focused too much on monthly CC trades and will include more put trades in the future.
hope you are doing fine…..I have been enjoying my BCI membership and picking up some very good learnings over the last few months.
From July this year, I am considering a strategy going forward of really just concentrating one one good stock (at very max, two stocks) that I am confident in and knowledgeable on, and then applying the Cash Secured Put -> Covered Call -> Cash secured put approach. I would back this up with having some underlying protection via buying of puts.
I know this goes against the key principles of diversifying the strategy over a number of stocks from different sectors etc. What are your thoughts on this – any particular feedback or strategy modification – obviously not seeking any financial advice?
The PCP strategy is a wonderful approach to option-selling, so we’re off to a great start.
1 stock or maybe 2 is extremely risky. Even great companies can get hammered. Bear Stearns, Enron … there are many more.
If the goal is to generate cash flow with as few securities as possible and yet not breach our diversification requirement, consider turning to exchange-traded funds (ETFs) which are baskets of stocks, much like mutual funds, but trade like stocks.
For example, the Select Sector SPDRs, divide the S&P 500 into 11 sectors. If we selected 3 of the best-performing Select Sector SPDRs, as shown in our mid-week ETF report (middle section of the report), we would own approximately 27% of the entire S&P 500 and be well-diversified with only 3 securities.
You can paper-trade this approach and see if it aligns with your strategy goals and personal risk-tolerance. You may be pleasantly surprised.
Many thanks for the feedback Alan, much appreciated
This week’s 4-page report of top-performing ETFs and analysis of the top-performing Select Sector SPDRs has been uploaded to your premium site. One and three-month analysis are included in the report. Weekly performance has also been incorporated into the report although not part of the screening process. Weekly option availability and implied volatility stats are also incorporated.
The mid-week market tone is located on page 1 of the report.
New members check out our ongoing and never-ending training videos (“Ask Alan” and Blue Hour webinars). We add at least one new video each month. Only premium members have access to the entire library of these training tools.
For your convenience, here is the link to login to the premium site:
NOT A PREMIUM MEMBER? Check out this link:
Alan and the BCI team