The main goal of covered call writing is to generate option premium cash flow. Many investors also seek to develop dividend income in addition to the option premium revenue. One security that presents a unique scenario is iShares 20+ Year Treasury Bond ETF (NASDAQ: TLT). This exchange-traded fund produces dividend income twelve times a year with ex-dividend dates on the 1st of every month. Ex-dividend dates are the main reason for early exercise of our options so how are we going to capture both premium and dividend income with ex-dates coming up in the middle of all monthly contracts?
TLT dividend information: www.dividendinvestor.com
TLT: Dividend Information
The screenshot shows:
- 12 dividends per year
- Ex-date on the 1st of the month
- Annualized trailing 12-month yield is 1.75%
- Dividend income since 2002
TLT 1-week option-chain
TLT: 1-Week Option-Chain on 4/17/2020
Trade structuring using The Ellman Calculator
TLT Calculations Using The Ellman Calculator
The spreadsheet shows:
- 1% 1-week initial time-value returns (52% annualized)
- 0.6% downside protection of the time-value profit for the $169.00 strike
- 0.5% upside potential for the $171.00 strike
Our best calculator for covered call writing and selling cash-secured puts is the new Elite-Plus Calculator.
Crafting the strategy to avoid ex-dividend dates
We never have a covered call option in place the week of the ex-date. This means that of the 52 weeks in a calendar year, we use only 40 of those weeks to write options or 77% of the time. This will reduce our potential annualized premium yield from 52% to 40%. Of course, many factors will determine final outcomes but we are at an excellent starting point. In addition to premium income, we add in the 1.75% dividend income we receive divided on a monthly basis. The pay dates come after the ex-dates.
Discussion
When seeking to generate both premium and dividend income, we must factor in ex-dividend dates. Securities with Weekly options like TLT allow us to write calls each week and simply avoid the weeks of the ex-dates. This strategy approach applies to securities that provide quarterly dividends where we can use monthly options 8 months of the year and turn to Weeklys the contract months of the ex-dates for those securities that also have weekly options.
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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:
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Upcoming event
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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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Alan,
I am wondering if the Nasdaq-100 Volatility Index strategy works with the weekly calls. If so do you need to divide the VOLQ price by 7.211 ( the square root of 52 instead of 3.46 the square root of 12 ) to find your 1 deviations from the price of QQQ, while still achieving your annual return of 10 -15%.
Thanks,
Allan
Allan,
You are 100% correct. There are 52 x 1 week time-frames per year and VOLQ is expressed in annualized returns.
VOLQ closed Friday at 37.81. Divide by 7.211 to calculate a 5.24% volatility in either direction.
With QQQ trading at $269.38, it is expected to trade higher or lower by $14.12 over the next 5 trading days based on VOLQ.
These stats will probably change a bit when the market opens on Monday.
Alan
Thanks Alan,
I was hoping you would confirm my thought process.
Enjoy the weekend
Allan
Alan,
Thursday the technical’s of EWW’s appeared to erode (I realized what happened at night) as the price dropped below the 100 day EMA with high volumes.
I checked my position at lunch Thursday and because the limit did not buy back the option, I did nothing. I originally purchased this ETF at $36.02, sold the 34 call for $2.71, and set the limit order to repurchase this ETF at $0.54.
This ETF temporarily dipped below the 100 day EMA. I did not think to do anything because the option value was ~ $1.24 which was still above the $0.54 limit order to buy back. I think I should have been aware of the price level of the 100 day EMA.
If I would have realized the price dropped below the 100 day ema with supporting high volume, should I have bought back the option and sold the ETF at this point?
Thank you for your help!
-Nathan
Nathan,
Congratulations on a well-structured trade where the initial 1-month time-value return (ROO) was 2% with 5.6% downside protection of that time-value profit.
Now, on Thursday everything went down… Friday too (well, not everything, but the market as a whole). EWW went down on Thursday, for sure, but was actually up by $0.44 on Friday to $34.16. The strike is still in-the-money.
If we created a 1-month comparison chart of EWW and the S&P 500, we would see EWW out-performing the benchmark the entire time.
Many times, no action is the best path to take.
Keep up the good work.
Alan
Good morning Alan!
At what point would it made sense to sell EWW?
-Nathan
Nathan,
Selling any underlying security should be considered if the stock or ETF is significantly underperforming the S&P 500.
For those who prefer a specific percentile threshold, a 7% – 8% price decline is reasonable.
For those who have the Elite-Plus Calculator, there is a 7% price decline column a shown in the screenshot below.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
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 10/30/20.
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 link to the BCI YouTube Channel is:
http://www.youtube.com/user/BlueCollarInvestor
Since we are in Earnings Season, be sure to read Alan’s article, “Constructing Your Covered Call Portfolio During Earnings Season”. You can access it at:
https://www.thebluecollarinvestor.com/constructing-your-covered-call-portfolio-during-earnings-season/
On the front page of the Weekly Stock Report, we now display the Top 10 ETFs, the Top SPDR Sector Funds, and the 4 single Inverse Index Funds. They are sorted using the 1-month performances from the Wednesday night ETF report and the prices from the weekend close.
Best,
Barry and The Blue Collar Investor Team
barry@thebluecollarinvestor.com
Nice article this week Alan.
Thank you, Terry.
Hi Alan,
I wanted to get your opinion on this type of trade. I like it because it has a lot of safety and a great ROO% for a 1 month trade. The UVXY’s low $16.06 and this trade’s break even is $14.58.
uvxy St/price (21.83) opt/price (7.15) call strike (16)
expires (11/27) time value (1.32) intr value (5.83)
break even (14.58) ROO% (8.30%)
Downside protection (26.70%)
Thanks for any input you have.
All the best,
Gerry
Gerry,
The propriety of a trade will vary from investor-to-investor depending on personal risk tolerance and strategy initial time-value return goal range. Also, we must keep in mind that there is no “free lunch” when it comes to investing.
For me, this is not an appropriate trade.
The 1-month time-value return is 8.30% with 26.70% downside protection of that time-value profit. At first glance, it appears that it’s too good to be true which raises a red flag.
The reason for these amazing stats is that the security is a leveraged (1.5x) security based on VIX futures contracts (volatility). It has an implied volatility of 209% compared to 33% for the S&P 500. This translates into huge downside risk.
I prefer to keep my initial time-value return goal range between 2% and 4% and may go as high as 6% in strong bull markets for 1-month near-the-money strikes… never higher.
Each investor must decide the suitability of a trade based on personal risk tolerance.
Alan
Hi Alan,
Thank you so much for your reply. I now understand why this is not a good trade. I see it’s best to just keep it conservative. Thanks for enlightening me to how volatile the UVXY is and the downside for this type of trade.
All the best,
Gerry
Link to my Trade Talks interview by Nasdaq reporter, Jill Malandrino:
https://www.nasdaq.com/videos/tradetalks%3A-how-to-use-the-nasdaq-100-volatility-index-volq-in-covered-call-writing
May have to turn on sound after a brief ad.
Alan
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The mid-week market tone is located on page 1 of the report.
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ALAN,
PLEASE HELP ME OUT HERE. I RECENTLY READ THIS ARTICLE ON WRITING WEEKLY COVERED CALLS ON TLT BUT I AM CONFUSED. I KNOW YOU DO NOT WANT TO OWN A COVERED CALL OVER AN EX DIVIDEND DATE. IF THATS THE CASE, HOW DO YOU COLLECT THE DIVIDEND IF YOU DONT OWN COVERED CALL OVER EX DIVIDEND OR DO YOU OWN THE STOCK FIRST OVER THE EX DIVIDEND DATE AND THEN WRITE THE COVERED CALL? IF THATS THE CASE WHEN DO YOU WRITE THE COVERED CALL, IS IT AFTER THE PAYOUT DATE?
THANKS,
MARK
Mark,
When we create a covered call trade, we first buy the underlying security, TLT in this case. The week of the ex-dividend date, we do not sell the call option but we still own the ETF so we, the covered call writers, are entitled to collect the dividend.
We then write the covered call option the day of or the day after the ex-date. Focus only on the ex-date, not the pay date.
Alan
Dear Alan,
I have an occurrence where a sold covered call is no longer profitable as the stock price has gone up drastically.
Whether to close the covered call early to cut loss or wait further near the expiration hopefully the price may come down (rather ironically). Or adjust the covered call.
Lots of emotions in play.
Which makes me wonder whether there are any algorithms out there that will help automate such decisions!
Would love to hear your insight on this!
Thanks,
Tim
Tim,
When we enter a covered call trade and share price accelerates substantially, the first emotion that comes to mind is elation… we have maximized our trade return.
To frame it that we are now “losing money” is analogous to winning the lottery and then breaking out the Kleenex because of all the taxes we will have to pay.
There is a BCI exit strategy available for such situations that creates opportunities to take advantage of these scenarios… the mid-contract unwind exit strategy. Here is a link to one of the articles i published on this topic:
https://www.thebluecollarinvestor.com/covered-call-writing-mid-contract-unwind-exit-strategy/
Alan