Covered call writing is the main focus of this site and the BCI methodology. Based on member demand and similarity of strategies we have been adding information on selling cash-secured puts, the topic of my upcoming 5th book. Recently I have received inquiries on related strategies that have led to some confusion specifically about covered puts so I decided to devote this article to that topic.
Defining the two strategies
Covered calls = Buy stock + sell call option = long stock + short option
Covered puts = Sell stock short (borrow shares from broker) + sell put option = short stock + short put option
Note: Selling cash-secured puts is a 3rd strategy that involves only a short put option position secured by enough cash to purchase the shares if the option is exercised.
Outlook for covered puts
A writer of covered puts has a slightly more bearish outlook than does the covered call writer as you will see as we calculate returns later in this article.
Sell short 100 shares of BCI @ $52 = $5200 cash generated into your brokerage account
Sell 1 x $50 out-of-the-money put for $1.50 = $150 cash generated into account
We now have two obligations: One to buy the shares @ $50 if the option holder chooses to exercise and the other to replace the 100 borrowed shares.
$53.50– any move above $53.50 will result in a loss. At this price we will lose $150 replacing the shorted stock (sold at $52 and bought @ $53.50) which is compensated for by the $150 put premium sale.
$2 on the stock side ($52 – $50) for closing prices under $50 + $1.50 from the put sale = $3.50/share = $350/contract
No matter how low the share price moves, we purchase the shares @ $50 due to our put obligation and this is why covered puts is a bearish strategy as we max our trade as share price declines and lose money if share price accelerates past the breakeven ($53.50 in this case).
Technically, unlimited as share price rises above $53.50, but $150 less than if the put was not sold and only the stock shorted. This also assumes no position management, an unfair assumption for educated investors.
Covered put graph
Type of brokerage account required and level of trading approval needed
Since the strategy involves shorting a stock, a margin account (not a cash account) is required with a high level of trading approval, much higher than that required for covered call writing.
Margin and interest
This will vary from broker-to-broker but a typical margin requirement of the short stock sale is 50% ($2600 in this case) and none on the options side. Since we are borrowing the stock from our broker, we will be required to pay interest on that loan and this should be calculated into our results.
Most strategies if implemented and managed properly can be profitable. For most retail investors, covered puts are not appropriate and should be considered only by experienced, sophisticated investors. Covered puts and selling cash-secured puts are two completely different strategies.
Ask Alan videos and website enhancements
Now that I’ve produced over 100 Ask Alan videos covering a myriad of topics related to covered call writing we have developed a tremendous media database for our members. Thanks to all of our subscribers, both general and premium, who have supplied these valuable questions. Related to this milestone I have asked my great team to undertake the following project:
- Create a link to a page of “The Best of Ask Alan Videos“
- Each of these 10 videos will address a question related to one of the 10 categories featured in the series
- We will provide a dropdown menu of topics and a keyword search
- The 2nd Wednesday of each month, I will produce a new Ask Alan video and make it available on the general site as we have in the past and this new video will be rotated into our Best of Ask Alan video series
- Create a link to ALL 100+ Ask Alan videos
- As new Ask Alan videos are produced, they will be added to this database
- A dropdown menu of categories and a keyword search will be available to provide the pertinent information sought
Now that we have successfully migrated both our general and premium sites to more powerful servers, we have the ability to provide even more information and services than we have in the past and in a highly user-friendly venue. In the very near future we will be adding information related to selling cash-secured puts as my 5th book is near publication and I also envision a 3rd section of the Blue Collar website devoted to students and longer-term investing.
I will never lose sight of the fact that without you the Blue Collar brand and name could never have become what it is today and I will always be grateful for your support. Thank you.
What a difficult and strange week it was for the stock market! Why was there such a sharp decline? Geo-political events? Global economic concerns? Perhaps, but how about another theory…the economic reports were so good this week that institutional investors are hypothesizing that interest rates will be elevated sooner than anticipated. I am still scratching my head. In any case, this week’s bullish economic reports:
- According to the Commerce Department, GDP for the 2nd quarter came in at an annualized rate of 4%, better than the 3% expected
- The 1st quarter GDP decline was revised upward from (-) 2.9% to a less steep (-) 2.1%
- According to the Labor Department, the Employment Cost Index for the 2nd quarter rose by 0.7%, more than the 0.5% predicted by analysts. A rise in wages bodes well for higher consumer spending
- In a statement released after the July 29 – 30 FOMC meeting, the central bank noted how economic activity rebounded in the 2nd quarter with labor market conditions improving. Bond purchases were reduced by $10 billion to $25 billion and should be over by October
- The Fed maintained interest rate guidance between 0 and 0.25% and projected that target for the foreseeable future
- The US economy added 209,000 jobs in July, less than the 235,000 anticipated but May and June stats were revised higher by a combined 15,000 jobs
- Job increases have exceeded 200,000 for each of the past months
- The unemployment rate edged up from 6.1% to 6.2% but well below last year’s rate of 7.3%
- 1.7 million people were added to the labor force in the past 12 months
- According to the Commerce Department construction spending declined by1.8% in June, below expectations
- The Conference Board’s Consumer Confidence Index rose impressively to 90.9 in July well above the 85.3 predicted fueled largely by an improving labor market
For the week, the S&P 500 declined by 2.7% for a year-to-date return of 5%.
IBD: Uptrend under pressure
GMI: 3/6: buy signal since April 22, 2014
BCI: This site remains moderately bullish on the economy but will use in-the-money strikes to enter new positions until the market behavior becomes clear
My best to all,
Alan ([email protected])