Selling stock options is all about generating a cash flow. Calculating our initial profit, the potential for more profit (upside potential) and the protection of our initial profit (downside protection as opposed to breakeven of the entire position) is critical in making the most educated investment decisions. Accessing this information from the “Multiple Tab” of the Ellman Calculator will assist us in stock, option and strike selection.
This spreadsheet allows you to evaluate multiple equities and multiple strike prices all on one page. The spreadsheet below depicts a typical page with information filled in and results shown:
Enter the required information in the left five blue columns. These statistics are derived from the options chain:
- Stock symbol
- Stock price
- Option premium
- Strike price
- Expiration date
The “multiple tab” is the tab that I use the most. When deciding on which financial soldiers to send out into the investment battlefield for a particular month, this page allows us to compare a myriad of stocks and their corresponding potential option returns, upside potential and downside protection. In this example, one glance of the page will show us:
- Option sales with the greatest initial returns (ROO)- time value of option premiums
- Highest upside potential- from stock price to strike price for out-of-the-money strikes
- Best downside protection- intrinsic value of in-the-money strikes
We then make our decisions based on market tone and technical analysis. In the chart above, we see, highlighted in yellow, out-of-the-money strikes which offer excellent initial option returns and the possibility of significant additional profit from share appreciation. The areas shaded in green represent in-the-money strikes which also provide outstanding 1-month returns, no upside potential but significant downside protection. It is important to note that when I refer to “downside protection”, I am referring to protection of the time value of the option premium, not the overall position. When we sell an option, the protection of the total position, or breakeven, is the entire option premium.
Favor yellow highlighted stocks:
- Bull markets
- Outstanding technical picture for the stock
Favor green highlighted stocks:
- Slightly bearish or volatile market tone
- Mixed technicals for that equity
Current BCI outlook:
For the past few months I have been “laddering strikes” or mixing ITM and OTM strikes. This choice is based a moderately bullish market outlook tempered by global concerns especially the European debt crisis. The power that this tool offers us is that once we have screened out greatest performing securities we can make our final stock and option decisions based on common sense principles and mathematics. This page can be printed and brought to your computer when you are ready to start generating cash into your accounts.
Beginner’s Corner Series:
Have you checked out our new Beginners Corner Series? This is a must for all who are starting their covered call writing career. I produced a series of 8 videos which serve as a primer for the BCI covered call methodology. Each video has a powerpoint file that can be downloaded and printed out as you review the material. And best of all it’s FREE. Here’s the link:
Stocks that report same store MONTHLY retail sales stats (“banned stocks”):
JCP has been removed from our list (and eligible for screening) since it no longer reports on a monthly basis. In addition, ASNA (Dress barn, formerly DBRN) no longer reports sales stats monthly so it, too is longer a “banned” stock. Also, please make sure WMT is on your list. This updated list is archived on the premium site in the “resources/downloads” section.
Economic reports pointing to an expanding economy continued this week:
- 227,000 jobs were added in February higher than the 210,000 expected
- Unemployment held at 8.3%, the lowest in 3-years despite a large number of people entering the workforce
- Consumer credit increased by $17.8 billion in January, higher than the expected $10 billion. Much of this was related to auto and student loans
- The trade deficit widened to $52.6 billion in January, the largest since October, 2008
- The ISM nonmanufacturing business activity index rose in February for the 3rd consecutive month to 57.3% ( > 50% shows expansion)
- US factory orders declined by 1% in January, the largest decline in 15 months. Experts feel that this represented a seasonal adjustment
- Productivity of US workers increased 0.9% in the 4th quarter, higher than anticipated
For the week, the S&P 500 rose 0.1% for a year-to-date return of 9.5%
With politics dominating the news lately I thought it would be interesting to look back to what we were dealing with the last time presidential primaries made headlines. In the recession of 2008, we were shocked by the collapse of our real estate and stock markets. Our portfolios and 401Ks took major hits and lives were changed. As an active real estate investor I know, as many of you do, that housing has not rebounded although it is showing signs of bottoming. The stock market, on the other hand, has surged dramatically the past three years and has the potential to climb a lot more if housing and unemployment continues to improve. These are difficult times for so many of us but the chart below reminds us that the foundation for continued recovery is in place and optimism for our financial futures is no longer a pipe dream:
Another great article. Thanks. Can you explain how you get the downside protection percentage. My calculations differ slightly. Thanks again.
Let’s take CTRP $38 call, the second green row:
Stock price: $40.29
Option strike: $38
Option premium: $4.00
Intrinsic value of the premium = $40.29 – $38 = $2.29
Downside protection = $2.29/$40.29 = 5.7%
This means that the ENTIRE 4.5%, initial option return (time value) will be realized as long as the stock price does not decrease by more than 5.7% during the contract period.
I just watched the first 3 videos in the Beginners Corner. Really helpful. Thanks for thinking of us newbies.
The Weekly Report for 03-09-12 has been uploaded to the Premium Member website and is available for download.
Barry and The BCI Team
Can you explain “ER date inaccurate” when it appears in the comments section of our weekly reports?
Keep up the good work.
ER dates without specific confirmation (usually from EarningsWhispers.com) tend to be best guesses. When we check for ER dates, we check multiple sources to see if there is any “agreement” of the ER date. The few times when we only can find only one source that has a date, we call the date inaccurate and the data tends to be inaccurate.
Specifically with DISCK and MSM, there was only one source that had ER date info. We usually check:
This week, only IBD had ER data for these two stocks. Since we couldn’t get confirming data from EarningsWhispers.com, Yahoo, and Earnings.com…we added the note so you would not make any decisions based on inaccurate data.
As mentioned in a number of past postings, we use EarningsWhispers.com as our “source of truth” because it has been the most accurate over the last few years.
Are all the options in the spreadsheet from this article eligible? How can we tell from the percentages if any are considered too volatile like your Taser example in your first book?
Thanks for your help.
Yes they are all eligible and based on your market assessment (I publish mine on the weekly blog articles) you can favor ITM, ATM or OTM strikes.
The “Taser” example I wrote about in “Cashing in….” was to point out the severe cost of selecting a security solely based on premium return. In the above spreadsheet, the equities were selected based on the strict screening requirements of the BCI methodology. Now, if I see a return of > 7% for an ATM strike I will (more often than not) avoid that equity/call trade because the implied volaility of the option tells me that the market is anticiapting a large price movement that can be in either direction.
I noticed that you added ASNA to your stock list this week. My wife loves Dress Barn so I looked at the options. The 42 and 43 April calls both return about 3%. How would you decide on which one to use? Thanks for any assistance.
This is precisely the scenario where you would use the multiple tab (or single tab) of the Ellman Calculator. As of 1:30 EST, here are your choices with the stock price @ $42.84:
2.8% return with 2% downside protection of that profit
3.4% return with little upside (this is a near-the-money strike at this time)
2.1% return with 2.7% upside potential for a possible total return of 4.8%
Depending on your market assessment and personal risk tolerance the calculator will show you the choices from which you can make your best possible decision.
Thank you for adding the subscribe without commenting. Is it possible to make that permanent for all weeks? I like to follow the discussions by email on my phone – it’s easier then going to the web site.
This link should do it:
Thanks for your great suggestions that have helped enhance the quality of this site.
Alan, how do you or how should we think about your Blog articles versus your SeekingAlpha articles? I haven’t tracked them but do you publish your Blog articles about a year later in SA? Or asked differently, if we’re reading your Blog articles, is there any reason to read the SA articles? Steve
I am frequently asked to write articles, present seminars (Atlanta- April 14th and NY- May 8th) and get interviewed in venues other than this site. I accept as many as possible with the intent to reach the largest audiences possible. However, there will NEVER be new information disseminated at these venues that haven’t first been published on this site. My primary loyalty is to you, our members.
By appearing in these other locations I can reach more retail investors and hopefully play a role in assisting more Blue Collar Investors to become CEO of their own money.
When I publish an article in other venues, it was previously published on this site either a few months ago or in some cases a year or two ago.
I currently own PII at a cost basis of about 61 and sold the March 70s. The price is about 66.50. If the option expires out of the money what is the best action to take considering an earnings release on April 19th? Thanks.
If you like the stock and want to keep it, you can buy a protective put and pay for it with a call, forming a “collar”. This will protect your position through earnings. After the ER you can decide how to trade the position based on the post-ER price behavior…knowing that your position is protected through earnings.
See page 204 of Alan’s new book. Either sell the stock before the earnings report or “own the stock through the earnigs and then sell the option after earnings are reported and the price settles down”.
Running list stocks in the news: INVN and UBNT:
I got 3 “doubles” this month and INVN was one of them.
You made my day!
Would it be possible to put page numbers at the top or bottom of the weekly stock screen and watch list? Sometimes I print the front and back of the sheet of paper and it would be helpful.
I’ll see what I can do to change the footed.
Most of the stocks I selected from our list are higher than the strike prices I sold (it’s been a good month!). When do you start calculations for rolling the options? Thanks a lot.
I’m in the same situation with most of my options. I plan to wait until friday afternoon so the time value of the march options gets as close to zero as possible. Good luck.
Like Amy, I roll my options as close to 4pm EST on expiration Friday as possible. If I’m busy that Friday, I’ll execute these trades on Thursday.
Real Life Trade: LPSN:
One of our members shared this trade with me. I thought the trade, his inquiries and my response would be of interest to many of you:
Just thought I’d share my first virtual trade following your course after one month!!
Following the release of the weekly screen 17/02/12 I selected LPSN. I plugged in ITM and OUT options premuims into the Ellman calculator and selected an OTM option as this was giving me the following return:
LPSN $ 14.90 $ 0.55 $ 15.00 03/16/12 $ – $ 0.10 3.7% 0.7% 0.0%
Here’s the breakdown:
02/21/12: Bought 500 LPSN @ 14.90
02/21/12: STO 5 LPSN Mar12 15 Call @ 0.55
By 03/12/12 share price for LPSN was 16.50 (almost 11% growth in share price) and I deemed this to be deep in-the-money and thought about deploying the unwinding strategy. Plugging the figures into the calculator revealed that the ROO was going to be >2% for a 20 day period.
03/12/12: BTC 5 LPSN Mar12 15 Call @ 1.55
03/12/12: Sold 500 LPSN @ 16.51
Plugging the figures into the calculator gave me the following:
RETURN ON OPTION (ROO) CALCULATOR – UNWIND NOW
Stock name >> LPSN
Stock symbol >> LPSN Today’s date >> 03/12/12
RETURN IF I UNWIND THE POSITION TODAY
Cost of shares $ 1,490.00
Option premium received $ 55.00
Cost to buy back the option $ 155.00
Premium received on sale $ 55.00
Gain (loss) on close-out $ (100.00)
Proceeds from sale of stock $ 1,651.00
Cost of shares $ 1,490.00
Gain (loss) on close-out $ 161.00
Net Gain (Loss) to UNWIND $ 61.00
NET RETURN ON POSITION
Net gain (loss) to unwind position today $ 61.00 = 4.30%
Net cash to open position $ 1,435.00
Number of days position was open 20
Annualized return 78.00%
My commissions for the virtual trade (paper trading on CBOE) were $40 in total so in actual effect my ROO was:
Profit from gain in share price = (16.51 x 500) – (14.90 x 500) = 805
Loss from buying back options = (0.55 x 500) – (1.55 x 500) = -500
Net profit = 305
Commisions = 40
Net return = 265
ROO = net return / cost to buy stock x 100
= 265 / (14.90 x 500) x 100 = 265 / 7450 x 100
The above return is good for 20 days but on reflection:
i) I wonder if it would have been better to just let the option expire and take 3.7% (althought this does not take into considerations commissions)? Was this deep enough ITM to deploy this unwind strategy or should I have waited for further share price growth?
ii) If you had done any thing differently!!?
iii) Had I used this strategy too late in the cycle?
iv) Could I have done anything better?
I’m looking forward to this friday when I’ll be making decisions on the other 9 paper trades and learn from them.
You’re doing incredibly well after just one month. The trade worked out quite well. We’ll take 3.5% in 20 days. It takes nearly 2 years to generate that sort of profit with a 10-year treasury! The question is whether you should have executed the mid-contract unwind exit strategy or allowed the shares to be sold after expiration. There are two criteria I look at:
1- Is the time value of the option near zero? In this case it is ($1.55 – $1.50 = $0.05)
2- Can we use the cash generated from the sale of the stock to set up a second income stream in the SAME month with the SAME cash? Since you closed your position 4 days prior to expiration Friday the answer is probably not. Some investors will close a position like this just to capture most of the profit and protect against a short-term catastrophic drop in share price. There is nothing wrong with this. For me, I like to see both criteria met so I would have allowed the option to get exercised and shares sold after expiration Friday or rolled the option Thursday or Friday depending on the calculations.
Keep up the great work.
If a stock is trading right at the strike price on expiration Friday does it pay to roll the option or shiould I let the option expire hoping the shares aren’t sold?
If you plan to use the stock as part of your next month portfolio, I would roll the option. Even if the price is one penny above the strike it will most likely be exercised. The time value as 4PM EST is approached is near zero. If nothing else, you will save one commission.
Running list stocks in the news: VAL:
VAL is the 6th largest paint and coatings company in the world and has been on our premium watch list for 8 weeks. It trades at a reasonable 16x forward earnings. CEO Gary Hendrickson was bullish during a recent conference call as were analysts who project 17% earnings growth for 2012 and 13% for 2013. Share price has increased by 43% since December, 2011 and has outpaced the S&P 500 by 22% in the past year, 18.5% in the past 3 months. The momentum has continued as VAL has beat the “market” by 5% in the past month.
Our “running list” shows an industry segment rank of “A”, a beta of 1.07 and a dividend yield of 1.70. In 2011, VAL had 1 “meet” and 3 positive earnings surprises. See the chart below (click on chart to enlarge and use the back arrow to return to this blog).
This week’s 6-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site.
***WE have also uploaded the 2nd quarter 2012 list of “High Dividend Yield Stocks with LEAPS”.
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
Here are a few stocks/options I am considering rolling out this afternoon:
Remember no trades after 4PM EST.