One of the most common questions asked of me is: “How do I get started if I don’t have a lot of money to invest?” Another is “What is the most conservative way to start selling covered calls?” These questions evoke the same sentiments I had when I first began educating myself in this strategy:
- Fear of the unknown
- Excitement for the possibilities
- Preservation of capital
One of the techniques that conservative investors can employ as we build our covered call portfolio is dollar-cost averaging. This is a technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. The benefit of dollar cost averaging (as opposed to a lump sum investment) is that over time, more shares can be purchased at a lower price. For investors who are developing a portfolio large enough to then start selling covered calls this is an approach that should be considered.
Let’s say we have $1200 to invest. Instead of investing it all at one time, we could invest $100 on the 1st of every month (or whatever date you determine) for twelve months.
Does it go by any other names?
Dollar-cost averaging is also called DCA and Constant Dollar Plan in the U.S. and Pound-Cost Averaging in the U.K. and the currency neutral term of Cost Average Effect.
The Three Parameters:
- The fixed amount of money- in the above example, it’s $100.
- The investment frequency- in the above example, it’s once a month.
- Time horizon- in the above example, it’s one year.
How it works:
The reason we dollar cost average into a security is to ultimately own more shares at a lower price, which protects us from losing maximum capital if there is price depreciation. For example, assume you have $1200 dollars to invest in stock XYZ, and decide to dollar cost average your investment by purchasing $100 of XYZ every month for a year, regardless of what price XYZ is trading at in any particular month. Assume further that the price of XYZ depreciates from $10 per share in January to $5 per in December, as depicted below:
- January: $10 per share buys 10 shares
- February: $9 per share buys 11 shares
- March: $7 per share buys 14 shares
- April: $5 per share buys 20 shares
- May: $6 per share buys 17 shares
- June: $9 per share buys 11 shares
- July: $10 per share buys 10 shares
- August: $11 per share buys 9 shares
- September: $12 per share buys 8 shares
- October: $10 per share buys 10 shares
- September: $9 per share buys 11 shares
- October: $7 per share buys 14 shares
- November: $6 per share buys 17 shares
- December: $5 per share buys 20 shares
Over this 1-year time frame, we purchased 182 shares. Had we invested the entire $1200 in January when XYZ was trading at $10 per share, we would have purchased only 120 shares. Yes, we still lost money, but not as much had we not dollar-cost averaged our investments:
- Money lost with a 1-time investment: $600 (120 shares x $5) = $600 remains from $1200 investment
- Money lost with dollar-cost averaging : $290 (182 shares x $5) = $910 left from $1200 investment
Disadvantages and criticisms:
Before investing our hard-earned money, it is critical to also understand the criticisms, both valid and invalid, commonly associated with dollar cost averaging, which include the following:
1- It is a marketing gimmick that lulls worried investors into investing more than they normally would have. I think this criticism was created by pundits who suggest that fear is somehow a positive. The market historically goes up, and in my view, no one has developed the skill to perfectly time the market, as there are way too many parameters that influence market direction. How can a computer software system or a great economic mind quantify market psychology, or ever-changing news or global influences? Even Warren Buffett lost a tremendous amount of wealth during the recession of 2008. If we can agree that accurate market timing is not possible, and that we will only invest what we can afford, dollar cost averaging can be a great strategy for most neophyte and conservative investors.
2- Dollar cost averaging ignores transaction fees: This is a valid concern, but one that can be easily avoided by using the appropriate investment vehicles. In our hypothetical example with stock XYZ, had we paid a $25 transaction commission fee for each of our monthly purchases, our bottom line would have been dramatically negatively impacted. That is why dollar cost averaging works best with mutual funds or ETFs when using extremely inexpensive online discount brokers, especially when investing modest amounts of money. A typical no-load index mutual fund can have an expense ratio (the cost to invest in a mutual fund, determined by dividing a fund’s operating expenses by the average dollar value of its assets under management) of 20 basis points. This means that for a $100 investment, you would pay only 20 cents, and not the $10 to $25 fee typically charged by discount brokers to execute an individual stock purchase. When considering which underlying securities to purchase in contemplation of selling covered calls, dollar cost averaging into ETFs through an inexpensive (but quality) online discount broker, or into a no-load index fund, can prove to be a conservative cost effective strategy, and one particularly useful to the neophyte covered call writer, as noted above. In short, by investing with the appropriate investment vehicles and using a cost-efficient broker, transaction fees can become a non-event. Note: There are no transaction fees when you buy Schwab branded ETFs online, some of which are optionable. Some Schwab ETFs have a lower expense ratio than Vanguard, iShares, or SPDRs.
3- We will miss out on profits if the market appreciates dramatically from the time of the initial investment: Once again, this is a valid point. The hypothetical dollar cost averaging example detailed above (in stock XYZ) is a negative scenario, or one that we need to protect ourselves from. In that example, had the market took off like a rocket ship, we would have ended up buying shares at higher and higher prices. This potential drawback is the price we pay for risk management. Most of us who use the dollar cost averaging technique cannot afford to lose large amounts of money, and downside protection from large losses is precisely what this strategy offers. Although this downside protection comes at the potential cost of missing gains in an uptrending market, we accept that cost and sleep better at night.
It pays to exercise caution when it comes to investing our hard-earned money. For those just starting out in the stock market, or for conservative investors in general, dollar cost averaging into a no-load index fund with a low expense ratio, or an ETF with a great online discount broker, may be a sensible choice. Many mutual funds also have automatic investment plans that allow you to invest a fixed amount automatically each month. Many times, the initial minimum investment needed to get started is much lower when automatic investing is set up. This technique will allow us to build a large enough portfolio of securities to then start selling covered calls while maintaining proper diversification. One excellent starting point to look for low expense ratio index funds is:
COUPON DISCOUNT for Alan Ellman’s Encyclopedia for Covered Call Writing:
We are offering a discount of $5 + FREE SHIPPING for Alan’s newest book: Alan Ellman’s Encyclopedia for Covered Call Writing. The total discount will be $8.75 GOOD UNTIL October 31st, 2011. Premium members are ALSO entitled to your everyday premium discount (***enter the Blue Collar store from the premium site). Be sure to enter coupon code “book3″.
For those of you who have already ordered the book, shipment started Wednesday and we are shipping twice a day to keep up with the demand. We are truly humbled by your overwhelming support. At this time, the book is only available from this site but will be available on Amazon.com in the near future. The lowest price will be from this site. Here is the link to the Blue Collar store:
Here is a summary of this week’s mixed economic reports:
- The Conference Board’s leading economic indicators rose 0.2% in September for the fifth straight increase but the lowest since April
- The latest Beige Book reflected a slight increase in economic activity for September and week 1 of October
- Consumer prices rose 0.3% in September meeting analyst expectations and suggesting that inflation is not a concern
- Core producer prices rose by 0.2%
- Sales of existing homes fell by 3.0% in September but…
- New residential construction skyrocketed by 15% in September mainly from a surge in multi-family units
For the week, the S&P 500 rose by 1.1% for a year-to-date return of 0.1% including dividends.
A 3-month chart of the S&P 500 is showing signs of a possible breakout to the upside:
We see a slight breakout from the trading range but on less than spectacular volume. The chart is encouraging but let’s not breakout the champagne just yet.
IBD: Confirmed uptrend
BCI: Cautiously bullish, fully invested and favoring in-the-money strikes.
Thanks again for your incredible response to my new book. I hope you enjoy it and benefit from it.
Much success to all,
Alan ([email protected])
I ordered your new book but would also like to get it in kindle if available. Please let me know.
Is there a way to permanently set the parameters on stockcharts.com so it doesn’t have to be reset each time you return to the site?
Yes. My new book will be available in kindle format and available on Amazon.com within the next few weeks. Thanks for your interest.
Following up on last week’s discussion of dsw (rolling) I was looking at this stock to start a new position tomorrow. With the stock up to 52.30 would it still pay to sell the 50 call option?
Yes, here’s what I did:
1- Go to http://www.stockcharts.com
2- Set up the technical parameters as discussed on pages 71-73 of my new book or page 85 of “Cashing in on Covered Calls”.
3- Copy and paste the URL (see yellow highlighted area below) into “my favorites”. I named it “Stockcharts Presets”.
4- Once you retrun to this preset, type in the ticker of a new stock in the green highlighted area. All presets are saved.
See the screenshot below. Click on the image to enlarge and use the back arrow to return to the blog.
The Weekly Report has been uploaded to the Premium Member website.
Barry and the BCI Team
This is actually a terrific example of how to use an in-the-money strike. As of market close @ 4PM EST on Friday, here are the stats:
DSW priced @ $52.30
The Nov. $50 call sells @ $4
November contracts expire on the 18th
I inserted these figures into the “multiple tab” of the Ellman Calculator which I highlighted in yellow in the screenshot below. The results show that we are guaranteed a 1-month return of 3.4% as long as our shares do not depreciate by more than 4.4% during the contract month. Once again, click on the image to enlarge and use the back arrow to return to this blog.
There are several stocks on this weeks list (PM, LO to name two) that give a nice dividend. Can you recommend a site where I can get the ex dividend dates. Thanks.
Among S&P 500 companies reporting so far, seven out of ten have posted higher profits than expected, called “beats” in Wall Street talk. For all S&P companies, profits are now on course to rise 14 percent, the eighth quarter in a row they will have grown more than 10 percent. Profits for 2011 are on pace to surpass the annual record set in boom times four years ago before the recession of 2008. Global issues are keeping this market in a trading range, not corporate performance.
My assumption is that you are concerned that the option holder may exercise the short call early to capture the dividend. If that occurs your covered call return for the month will have met its goal…mission accomplished. You may also have enough time left in the current contract cycle to use the cash from the sold shares to develop a second income stream in the same contract month…more cash for us!
If however, you are looking to avoid early exercise, it will usually occur the day prior to the ex-dividend date where the time value of the option is less than the dividend to be captured. One site FREE to access ex-dividend dates is:
Type in ticker on upper left area and hit “get quote”
Look to left column on the next page under company news for “key statistics”
I have highlighted in the screenshot below the next page.
The yellow highlighted area is the “key statistics” link I alluded to above. The green highlighted area is the ex-dividend date information. Click on the image to enlarge and use the back arrow to return to this blog.
Once again I did five in the money calls this morning. I think this market is to crazy to trust. Any others doing the same?
Thanks Alan. One more question if I may. If I allow an option to expire in the money when will my shares be sold and when will the cash be available for use?
Thanks for all your help.
Stocks called away on expiration disappear from your account on Saturday and the cash appears at the same time. I ran a covered call on Riverbed last month. Bought at $23.25 and sold the Oct $23 call for $2.25. On Friday afternoon at closing the stock was $24.52. On Monday morning I had no stock, no option and an extra $2,290 ($2,300 – $10 trade fee) in my cash line.
I’ve been selling in the money options also for the last few months. Making about 2.5% per month and sleeping better at night. Waiting for things to settle in Europe.
How do you decide whether to enter a market or limit order? Bid-ask spread?
A market order will guarantee a quick execution of the trade. A limit order will guarantee a specific price or better IF EXECUTED. Most of the stocks on our list will have a tight (small) bid-ask spread so a market order will suffice. Option bid-ask spreads are wider and can (in many instances) be “negotiated” by “playing the bid-ask spread”. Here we enter a limit order. Those who use a buy-write combination form(combined stock/option trade) use a net debit limit order.
In general a market order is appropriate for most security purchases and sales and a limit order is appropriate for most option trading and buy-write combination forms.
I’ve been finding that market orders calculated by ThinkorSwim were not being filled. I added 5c or 6c to the order and they filled some times at the original price!
Your weekly report has listed GILD as passed all screens. From a couple of web sites that I have visited, shows their earnings on 10/27/11. I don’t know for sure if this data is correct but I am just listing it for the readers to be careful.
You are correct…GILD was incorrectly entered on page 1 as not having an ER in this option period, when in fact, Earnings Whispers shows it as 10/27/11 (unconfirmed). Thank you for finding this and I’ll correct and post an updated report shortly.
The Weekly Report has been revised and uploaded to the Premium Member website. Look for the report dated 10-21-11 RevB.
Barry and the BCI Team
This stock is a recent entry onto our premium report. On October 20th it reported a stellar 3rd quarter earnings report with revenues up 30% year-to-year and a 6% earnings surprise. TPX has averaged an 11% positive earnings surprise over the past 4 quarters. The company also bought back 1.34 million shares in the quarter worth $80M and still is authorized to buy back another $200M. Analysts are projecting a bullish 19% growth rate. TPX trades at a slightly pricey PEG of 1.10. Our premium report shows an industry segment ranjk of “C” and a beta of 1.37.
Check to see if this financial soldier deserves a spot on your watch list.
Recently we made a few enhancements to our premium reports (see the screenshot below):
1- All stocks scheduled to report earnings in the current contract cycle are now highlighted in gold for easier visualization.
2- All projected earnings report dates that are CONFIRMED on the earningswhispers.com site are now highlighted in red-bold as shown by the red arrow below.
The BCI team is constantly working to maximize the quality of the products we provide to our members. As always, thanks for your incredible support.
Alan and the BCI team
May I ask some questions about selling cash-secured put as mentioned in the Emergency Management Report?
1. How much cash will be secured by the broker?
2. How to calculate ROO ?
3. Any similar exit strategy as in selling cc?
4. A new position for selling cash-secured put involved 1 commission while the same for cc involved 2, thus the former save trading cost. Is it correct?
5. Simiarly, if there is dark cloud above the stock, the totally unwinding of the cash-secured put involved only 1 trade (buy back option)rather than 2 (buy back option and sell stock) in cc., thus the former provides a quicker way to escape. Please comment.
6. If not assign at expiration Friday, when will the secured cash be freed? Any fee or commission involved?
1- In a cash account, which is most appropriate for retail investors like us, you will be required to set aside the strike price x the number of shares minus the premium captured. A margin account can differ from broker to broker so you may want to contact your broker on this issue. For a general response to a margin account, use a margin calculator for “short puts”:
2- ROO = Premium captured/strike price x 100 per contract for cash accounts. I don’t use the premium to reduce cost basis when calculating initial returns.
3-A discussion of exit strategies is far too involved for a blog response. I wrote an entire book for this subject as it relates to cc writing. As a brief response, I would consider closing my short put position when the technical parameters dicate such as dropping below a moving average. I am planning to address puts in my next book which I will start early next year (I need a break from book 3 !).
4- True. An UNEXERCISED cash-secured put involves only 1 commisssion.
6- No fee for an option that expires worthless. The cash is available on the Monday after expiration Friday.
1. The broker will set aside the strike price times the number of shares you may be forced to buy. One $40 put contract would require $4,000 set aside to cover.
2. The calculator was not set up for naked puts, but it is a simple calculation. Divide the premium you receive by the amount set aside. So, if you received $243 (2.43/sh) for one $40 contract your return will be 6.08% ($243 / $4,000).
3. Unless you sell a put with the desire to possibly own the stock, the exit strategy is simple. If the stock price starts to get too close, get out.
4. Most brokers have a combination trade for selling or closing a covered call. It usually only involves one commission. I know this is true at OptionsExpress.
5. Similar answer to #4. OptionsExpress, and most other brokers, allow multi-leg trades which only involve one commission. If you are assigned, either a put, or a call, you will pay a commission for the stock trade.
6. As with any other option position which expires, the security is available on Monday morning at the start of the day. There is no fee for an expiring option. If you find a broker that charges one, run very fast to almost anyone else.
Hope this helps.
PS> In case any of you were still wondering why Alan strongly urges you not to hold a position when earnings are reported I suggest you wonder what would have happened if you owned NFLX Monday night, or AMZN yesterday. Enough said?
Looks like today is not a dental practice day. Alan jumped in before I could.
Recently reported its 18th consecutive positive earnings surprise. On October 18th 3rd quarter earnings were up 38% and sales increased by 26%. There was also a 63% increase in operating income. Analysts are projecting a 49% EPS growth this year and 19% next year. PII trades at a PE of 16.3 x forward earnings and a PEG of 1.1. Ther premium report shows an industry segment rank of “A”, a beta of 1.30 and a dividend yield of 1.60.
I decided to hold QCOR through todays earning report. I didn’t sell the option based on your rule. Well today the stock is up 7 dollars and i can now sell the option for another 3%. SWEET!!!!!!!!!!!!!!
Check out my PS on my #25 post.
I know you are right but I was feeling good about this company and decided to ride it through the report. As Alan states on page 204 of his new book “this is not part of the BCI system” but when you decide to hold the stock do not sell the option until after the report. It was a risk. I won this time. Next time, who knows?
Thanks for the advice.
Hello Alan ,
Okay, I was nervous and a bit cross-eyed, but here is a bit of a chuckle for you today.
I am a BCI newbie and feel good about your CC strategy and also firmly believe in the use of IBD for high quality stock picking. So yesterday, I decided to get some skin into the game and bot Polaris right in the middle of its pop in price. I am using Think or Swim (TOS) and it is a very complicated web site (for me at this stage of learning).
So now I am long with PII and wish to sell the 55 ITM call for a secure conservative position; wouldn’t you know, I was so anxious that I couldn’t find the option quote chain on TOS. I clicked on every button on my screen and got so frustrated and confused that I figured the only safe thing to do was to unwind the purchase and go back to zero. Yup, I did lose my commish and a few dollars of equity, but I was able to sleep last nite without feeling too stupid.
So this morning, with the belief that one has to get back on the bucking bronco, I decided to do a second round with QCOR “equity and call” after their excellent ER event. Believe me, I practiced a bit on TOS to make sure I could find BOTH the equity and option chain before I pushed send.
BTW, the use of the calculator made the ITM call strike price selection very easy; I’m not making an absolute amount of money (yet) to afford a trip to Italy , but I’m selecting a conservative ROO that is a lot better than my CDs and I am learning a new skill that will keep me busy in my retirement. This year, one contract; next year, ten contracts.
Aha, it worked–TOS got me into the game. So I have a covered call to follow this month and work exit strategies and create some excitement with the same enthusiasm that you and Owen Sargent show in your postings.
TOS is a pain until you get the hang of it. Go to TRADE enter the stock – select the month for the option and right click on the one you want. Select SELL – covered stock. This will do it in ONE transaction for ONE fee.
It will give you a net price. I like to adjust up a few pennies. I know this violates Allan’s ideas, but I get more fills that way.
The Weekly Report has been revised and uploaded to the Premium Member website. Look for the report dated 10-21-11 RevC.
Barry and the BCI Team
I am enjoying my Premium Weekly Report so far but I have a question concerning the revised reports; Is there a simple way to know what was changed from the prior report without going through the whole thing again? Thanks.
Reported a stellar 3rd quarter earnings report on October 20th with revenues up 18% and a positive 12% earnings surprise. Over the past 4 quarters earnings have positively surprised by 18%. Analysts are predicting a bullish 16% growth projection. TSCO trades at a pricey PEG of 1.39. Our premium report shows a beta of 1.07 and a dividend yield of 0.70%.
You make a very good point. I will include a note when a revision is made going forward.
Most of the time when I issue a revision, it usually doesn’t impact any decisions that you would make from the previous report…most of the time it is usually a formatting change. However, we tend to see more revisions during the height of earnings season as we are in now. Typically we work with over 2,000 data points each week.
The revisions this week:
RevA – Changed item in note section of Watch List, no impact on any decisions
RevB – GILD…miscategorized although properly identified in the Gold section of the Running List…should not have impacted any decision this week.
Rev C – ALXN…during final formatting/date sort, did not sort properly and came up as having an ER in this period when it does not have and is now OK for the watch list. Noticed this after RevB was completed.
Barry and the BCI Team
Alan or others,
Do you view todays action as a sign that we are entering a bull market or at least a short term uptrend?
This week’s 6-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site.
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
Today was a wonderful day but still only one day. We had a delicious combo plate of an encouraging European debt deal, more positive corporate earnings and positive economic news. Wonder what the “shorts” were up to. I will enjoy this day as I go to bed tonight looking for additional positive confirmation before I change my investment approach. Let me add, however, that the bullish bandwagon has been getting a bit crowded the past few days as many of the TV experts have been changing colors.
On our premium watch list for 5 weeks, this company reported an outstanding earnings report on October 24th with earnings up 29% year-to-year and reveues up 23%. It was the 8th consecutive positive earnings surprise for VFC. In addition, the dividend was increased by 14%, the 39th consecutive year of higher dividends. Management raised guidance on both earnings and revenue growth as analysts are projecting earnings growth of 27% this year and 15% next year. Our premium report shows an industry segment rank of “A”, a beta of 0.97 and a dividend yield of 1.90.