Combining covered call writing premiums with high dividend yields can be an enticing investment approach. In October 2019, Gerry wrote to me about using MPLX LP (NYSE: MPLX) in her option-selling portfolio and pointed to the generous dividend yield and real-estate component as the reasons for this consideration. In the BCI methodology, we use fundamental analysis, technical analysis and common-sense principles (like minimum trading volume) to select our underlying securities. I would consider dividend yield as a secondary consideration or “icing on the cake” This article will evaluate the pros and cons of including this security in our portfolios as of October 2019.
Annual dividend yield as of October 2019
MLPX Dividend Yield from www.dividendinvestor.com
An annual yield of nearly 10% can be quite appealing but we haven’t looked into the 3 screening factors so important in our BCI methodology. Let’s focus in on the price-performance of this security over the past year.
Comparison chart of MPLX with the S&P 500
MLPX and S&P 500 6- Month Comparison Chart
With the S&P 500 virtually flat over the past year +0.,6%), MPLX was down nearly 20%. In this context, the dividend yield no longer seems attractive. One of the reasons a stock may have an unusually high dividend yield is that the share price has declined substantially. A $2.00 dividend on a $50.00 stock has an annualized yield of 4%. If share price drops to $25.00, that $2.00 dividend now represents an annualized yield of 8%
Discussion
Covered call writing is a strategy that generates a monthly (or weekly) cash-flow from option premium. The quality of the underlying security is critical to our overall success. Using dividend yield only will cause us to lose focus on the critical screening factors that will guide us to the highest level of success. One way to include dividend yield into our portfolios in a safer manner would be to consider the best-performing Select Sector SPDRs (in our Premium ETF reports) and the best-performing Dow 30 stocks (in our Premium Blue-Chip Reports). Our premium stock reports also show dividend information.
Overall, I consider dividend yield “icing on the cake” and not a primary consideration in security selection for our covered call portfolios.
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,
Thanks for your wonderful program and recent OIC presentation. I learnt from it and some follow up at your site- CC and CSP presentations. I’m very impressed with the BCI methodology, your presentations and advice.
Ashok
Upcoming event
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Market tone data is now located on page 1 of our premium member stock reports and page 8 of our mid-week ETF reports.
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Hi Alan,
Thanks for the great video on covered call writing on the VIX. My question concerns, of course, the strike prices.
Right now VIX is about 42 and VXX is about 44.
So, my understanding is that we should look at the May 20 options as follows:
Synthetic long stock via short (SELL) a 45 PUT and long (BUY) a 45 Call on VIX, right now debit is $5.40 – seems really high since :
Covered call via OTM PUTS are less than $5.40 across the board
What am I doing wrong here?
Thanks,
Ed
Ed,
Right now the VIX and VIX futures are similarly priced. When there is a disparity, use the futures contract price, not the VIX spot price, to establish the synthetic stock position and write the OTM call based on that strike. The screenshot below reflects how it would look based on recent pricing: Review the Blue Hour webinar #13 on the premium member site for an explanation why the futures price is important.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan
Alan and Barry.
I traded some June option against RGEN. In the event there is big swing on the underline after the earning report, what will be the impact on my option in general?
In other words, in general how long the earning report will impact the underline then it goes back to normal?
Keith
Keith,
The pre-report implied volatility is higher-than-normal in anticipation of the report and then subsides after the report. Premiums are directly related to implied volatility.
It usually takes 1-2 days for share price to normalize.
Alan
Thanks Alan. what is the percentage of stocks in our premium report had gap up or gap down in the past? that is the scary part of the earning report, right?
Keith,
Over the past several years, more earnings surprises are positive than negative. In my humble opinion, they still should be avoided. At the very least, if we want to retain the stock in our portfolio, do not write the call until the report passes.
Alan
Hi Alan;
I have the following question:
On 4/20 I bought 100 shares of VIPS at 17.84/ share and sold 19 call at 0.75.
Today VIPS is $16.02/share and if I want to buy back my call, the bid is 0.15 and ask is 0.35.
0.15 is 20% out of 0.75.
Question: How we apply the 20% rule to the bid or to the ask price of the call- since I have to buy it back at the ask price.
Thanks much !
Mihaela
Mihaela,
The 20%/10% (I prefer to call them) “guidelines” apply to the “ask” price. The best way to approach this is to immediately enter a buy-to-close (BTC) limit order of $0.15 (in this case) after entering the covered call trade. If we notice the ask price is close the threshold, but not quite there, it’s okay to close… it’s a guideline.
Alan
Thanks, Alan. I tried doing that , called Fidelity broker , I spoke with 2 , but no one was able to tell me how to do it on their software. I was a little disapointed in their customer service.
I just got your 4th book yesterday, “Selling Cash secured puts”. Thank you for all the info you shared with us! It’s outstanding.
Being a rookie, I will start building my portfolio selling puts for the stocks I want to acquire. Then go into calls.
There are so many strategies out there (Butterfly spread, Condor Spread etc etc) are people really using all those ?
Thanks .
Mihaela
Mihaela,
Let me add this to John’s interesting comment:
Fidelity definitely has a buy-to-close choice on its brokerage forms. All brokerages allow for our options sales to be closed. It’s usually something like this:
Go to “Trades”
Go to “Options”
Go to BTC or buy-to-close
Then enter the stock ticker (may be a dropdown), # of contracts and limit order along with GTC (good-until-cancelled)
Do not check the “AON” or “All or None” box.
If you need assistance from a rep, tell them you want to speak to an options specialist.
Yes, there are traders who use more complicated option strategies. All can be successful if the 3 required skills are mastered. You are starting in the right place and, like me, may never change. There is no one strategy right for every investor.
Alan
Mihaela, just another person here. What I do is when I enter to close a position I put in that I want to pay the bid price. A lot of times it will be taken. You may need to let it sit for a while to see. If I’m impatient for any number of reasons I adjust it up a penny or two to see if that is taken.
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 04/24/20.
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/
Best,
Barry and The Blue Collar Investor Team
barry@thebluecollarinvestor.com
Dr. Ellman.
Your books appear not to inclulde weekly options as covered calls. I’d love to get your thoughts and strategies using Covered calls on weeklys.
Also you speak about dividend yield not being as important in selling options. I agree to an extent,but how about the importance of a weekly search for maximum option return. Do you dislike weeklys?
Regard and thanks
Chris
Chris,
I’ve actually written quite a bit about Weeklys over the years. My personal preference is for Monthlys but I believe we can also be quite successful with Weeklys.
In both our Premium Stock and in our Premium ETF reports we make it a point to highlight securities with Weeklys.
Here are 3 of the many articles I’ve published on this topic over the years:
https://www.thebluecollarinvestor.com/portfolio-overwriting-with-weekly-options/
https://www.thebluecollarinvestor.com/rolling-weekly-options-covered-call-writing/
https://www.thebluecollarinvestor.com/expanded-weekly-options-when-should-we-enter-a-trade/
Alan
HI Alan,
I am trying to make myself a “when to sell the equity” flow chart to simplify how I look at a gap down situation. This is all the information you have provided. I am just trying to logically organize it for myself into a personal system. Admittedly, I am a risk adverse person. I realize that I am a beginner so there are many things I don’t fully grasp.
Would you mind providing me your feedback on how I am looking at this?
Step 1: Set limit orders to purchase options back at 20%/10% criteria
Step 2: If equity gaps down by 8% of more, buy back option and sell equity. If equity gap down is less than 8% proceed to step 3. I am looking for a clear worst case scenario here. If this worst case gap down occurs, immediately sell the equity. If the stock drops by 8% or more, will it likely meet your 20%/10% guidelines? What do you think about using 8% as the guideline for a worst cast scenario?
Step 3: If equity gaps down less than 8% sell if:
* Sell equity when market tone is negative and equity technicals are negative. For equity technicals to be negative, does that mean all four technicals
(EMA,MACD, STOCHASTIC OSCILLATOR, & Volume) are all negative?
* You find egregious news from finvis.com
* Equity significantly under performs S&P 500 How do you quantify this? Is this 1% or 2% under S&P 500? Is there a number you use?
Step 4: If gaped equity doesn’t meeting criteria of step 2 & 3 and market tone and technicals are mixed to negative, roll down.
Thank you very much for your time!
-Nathan
Nathan,
You’ve done an outstanding job of summarizing the BCI methodology as it relates to significant share decline.
8% is a reasonable price point consider selling the stock. Based on member feedback, the BCI community is using price percentages between 7% – 10%.
A technical breakdown would normally mean all 4 parameters. I put most weight on the stock price dropping below the 100-day EMA on high volume as a bearish signal.
Under-performing the S&P 500 with price changes diverging more and more is more significant than a 1-2% difference. With technical charts,. we are creating a mosaic of indicators and forming an opinion. It is, to a great extent, subjective. Under-performing the S&P 500, with that divergence increasing, along with a technical breakdown on high volume, are a series of events that should motivate us to close the position and move on.
Rolling-down is an exit strategy I prefer to initiate in the second half of as contract. In the first half I first look to “hit a double”
Nice work!
Alan
Hello Alan,
I really appreciate you taking the time to answer my questions. I have never invested in the market by myself so confirming my understanding of these concepts is very helpful. I am very excited about your system! This weekend I am going to subscribe to your premium monthly membership and at stockcharts.com. I will start paper-trading in the 1-month cycle after the 3rd Friday in May.
Thanks again!
-Nathan
Hi Alan
I plan to buy 3x bear financial ETF FAZ as a hedge for my holdings in financial sector. Today FAZ dips near all time low, will be ok to sell OTM puts (such as $24 May 15 $1.5) with the purpose of buying it at a discount? I understand the high return is mainly due to the high IV and you normally prefer ROO 2-4%.
Thanks
Lisa
Hey Lisa,
Alan will give you his views and please be guided by those.
I have some 3x ETF scar tissue from yesteryear so I had to weigh in :). I encourage you to get comfortable enough with ETF’s like FAZ to be able to explain to a stranger how they work before you buy one or use options on them. You may already be there and if so, great for you – they are complicated!
Please look at a chart of FAZ and also a chart of a long 3x ETF. You may be surprised to see both lose money over time.
They are intended as very short term trading instruments (a lot of day traders use them) and will almost always kill you if you go on holding them for any period of time in my experience.
In my opinion if you want to hedge bank stocks or the XLF ETF please use use collars, longer term put spreads with sold components to dampen theta on the bought puts or sell ITM covered calls.
The Fed has made it clear it has the Financial’s backs. So, again, only in my opinion, there are better ways to hedge them than an extremely volatile 3x ETF that has design flaws in how it is re-computed each day resulting in it being at all time lows in this lousy environment! They will likely reverse split FAZ soon just so it can start eating away at itself again. – Jay
Lisa,
Thanks to Jay for that insightful response and analysis.
Covered call writers and put-sellers are conservative investors focused on beating the market with a capital preservation component. The amount of risk we are taking can easily be measured with the time-value returns of our option sales. In the case of FAZ, we will generate a 6.7% 2 1/2 week return, an annualized return of 139% That says it all… too risky for most retail investors.
The premiums are enticing but before using these option-selling strategies we must define our personal risk-tolerance and convert that into an initial time-value return goal range and then
adhere to these parameters. For me, it’s 2% – 4% per month. I’ll go up to 6% in strong bull markets, never higher. Investors with higher or lower risk-tolerance can adjust that range.
I avoid all double or triple leveraged ETFs.
Alan
Hey Alan,
Thank you for the kind words you always extend to me and every other blog member who contributes here. You have a very nice manner about you.
Is it just me or has this market lost it’s mind :)? Here we have record unemployment, an economy in the tank, debt spiraling out of control, clueless leadership in Washington and yet the S&P grinds higher most days? I realize there must be a hell of a lot of short interest for the computers to squeeze. I wonder when they will change their mind and start squeezing out the longs?
I suspect somewhere buried in the NYSE Charter is a clause stating “our guiding purpose is to separate as many people from their money as possible” :)? That is why options sellers must drive them nuts :)!
Oh well, casual musings on another shut in day! – Jay
Jay,
I believe investors just don’t know what to make of the market. We’ve never seen anything like this before. On the one hand, we have concerns like the ones you alluded to and on the other…where else can we make money?
With the dividend yield of the S&P 500 many times greater than that of the 10-year Treasury, the market has an enticing aspect to it. That’s why I am so bullish on the long-term prospects of the market once COVID-19 is in our rear-view mirror.
Alan
Thanks Alan
Always a pleasure to chat with you and thank you for how you and Barry get back to us so quickly!
If I had fallen asleep under a tree ten years ago only to awake today I would marvel at how far the market has come. Always keep the big picture in mind. – Rip Van Winkle :).
Hello:
I just joined the BCI and find the information invaluable. I am just starting my covered call investing experience and do not grasp the concept of buying back the option. I think I understand it conceptually but how does one exactly buy it back?
I’m sure many other have asked this question, therefore please refer me to one of Alan’s videos or articles that will explain this in a simple manner.
Thank you.
Georgia
Georgia,
Good question. I asked myself that same question when I first started out.
When we sell a covered call option, the broker trading form (under the options dropdown) will say sell-to-open or STO). The trade will be reflected with (brackets) indicating an open trade.
Now, let’s say we want to close that open position or buy back the option. We go back to the options dropdown and will see a choice of buy-to-close or BTC. We select the option previously closed and set a limit order (that price or better). The trade can be entered as “day order” or good-until-cancelled (GTC).
Let’s say we sold the original option for $2.00 and now want to buy it back for $0.40. We enter a BTC limit order at $0.40 and, if executed, we no longer have an option obligation.
Alan
Hello BCI Team:
On my stock screen I saw that the call premium keeps changing, please explain why.
Thank you again for answering my questions.
Georgia
Georgia,
The prices of options change during the trading day much like the prices of stocks change. That’s the nature of a market place where buyers and sellers make bids and offers. The greatest volatility in price changes occurs early morning and late afternoon when computerized institutional trading peaks. For this reason, I like to enter my trades between 11 AM and 3 PM ET.
Alan.
Hi Alan
Thanks for your advice!
I plan to sell puts on DAL and LUV to get the discount for my holding, but hesitate to do so as they are included in the Banned List due to the Report Monthly Capacity Airline Statistics. I wonder how the report affects the options. I assume it will increase the volatility.
As always, thanks for your guidance in advance!
Lisa
Lisa,
Airline capacity reports are similar to earnings reports where an additional layer of risk (and increased volatility) is added to our trades. That’s why they appear on our “banned list”
If you already own these stocks and sell puts, you are accepting the possibility of increasing your positions. If your goal is to lower cost-basis on existing holdings, you want to sell call options.
To add an additional layer of protection to a covered call trade, buying a protective put will place a floor on the trade and lower overall returns.
Alan
Hi Alan,
I have several positions with > 20% unrealized loss (SNBR, RH, SNX, FND, etc.), which I was not able to get out of before they tanked because I was in recovery from covid.
You mentioned before that I can keep on selling OTM calls in order to gradually lower my cost basis. How do I do this effectively without taking a huge realized loss, just in case the calls get exercised? Do you have a guideline/computation on factors to consider (whether we should just stay uncovered and wait for the stock to go back up), and how far OTM should we sell? Weekly or monthly?
Thanks in advance!
Bryan
Bryan,
So glad to learn you are recovering from the virus.
If we decide that securities in our portfolio that have declined in value are still worthy of retaining, we roll down to out-of-the-money strikes. I prefer to stay with monthly expirations but Weeklys will work as well.
If the strikes are in-the-money as expiration approaches, we can roll the options to the next contract month if share retention is still our objective.
I noticed that yesterday RH was up 4%, SNX was up 9% and FND was up 8%. You’re not the only one recovering!
Continued good health.
Alan
IWM is melting up….Don’t fight the Fed.
Hey Terry,
Always nice to hear from you, hope all is well!
Since most of the government stimulus is targeted at small business I have been making long option trades on the IWM and they have worked so far! But, as always, tomorrow is another day!
Hi Jay;
Great to hear from you.
I also am in long term option IWM trade. It has “catching up” to do to the Q’s and SPY.
Best of luck;
Terry
Thanks Terry,
Since we are up against a wall of resistance on the indexes and it is about time for the markets to catch their breath I have sold a bunch of covered calls for next Friday. I usually don’t do that in uptrends but it seemed a reasonable play expecting downside.
And what is the old saying, “Sell in May and go away” :)?
I have found since commissions went away it makes more sense to sell the weeklies and not risk as much lost opportunity if the market goes up. But that is only my opinion. – Jay
Premium members:
This week’s 8-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site. The report also lists Top-performing ETFs with Weekly options as well as the implied volatility of all eligible candidates.
Also included is the mid-week market tone at the end of the report.
For your convenience, here is the link to login to the premium site:
https://www.thebluecollarinvestor.com/member/login.php
NOT A PREMIUM MEMBER? Check out this link:
https://www.thebluecollarinvestor.com/membership.shtml
Alan and the BCI team
Hello BCI Team:
…and thank you again for answering my questions in a timely and clear manner.
Question: since the economy seems to be in uncharted territory with high unemployment, disrupted food chain etc…wouldn’t this cause market volatility and if so wouldn’t weekly options be a better choice rather than monthly options?
Thank you.
Georgia
Georgia,
Very perceptive of you. Yes, these events result in increased market volatility although the initial spike in volatility has recovered to some extent. The current market volatility (VIX) is still historically high (34.15). This means higher premiums and greater risk for investors.
Now, Weeklys versus Monthlys is a decision each investor must make. I’m in the Monthly camp but believe we can be successful with both as long as we have mastered the 3-required skills.
Alan