Covered call writing and put-selling results are enhanced by selecting the best underlying securities and most appropriate options. Stock selection involves screening via fundamental and technical analysis as well as common sense screens (like avoiding earnings reports). Option selection is based on several factors including chart analysis, overall market assessment and personal risk tolerance. In this article, we will focus in on overall market assessment using the myriad of weekly economic reports available to us.
These reports can be categorized into four major groups:
- Labor market conditions
- Consumer health
- Business health
- General economic indicators
Here is a summary of several of the most critical reports:
LABOR MARKET CONDITIONS
A monthly report of the number of persons on nonfarm payrolls, the rate of unemployment, and workers’ average hourly earnings. It is considered a very timely and accurate reflection of labor market conditions. The unemployment rate is a key business cycle indicator.
Initial Jobless Claims
A weekly report of the number of individuals who filed for unemployment insurance for the first time the prior week.
A monthly gauge of consumers’ attitudes about the present economic situation as well as their expectations regarding future conditions. Consumer confidence tends to have a strong correlation with consumer spending patterns.
Personal Income; Personal Spending
A monthly report of the income that households receive from all sources. Since income is the major determinant of spending, the report is an indicator of future consumer spending patterns.
A monthly report of the dollar value of sales of a broad range of goods. Retail sales are a major indicator of consumer spending trends.
A monthly measure of the number of orders for a broad range of products with an expected life of at least three years. Durable-goods orders are a leading indicator of industrial production and capital spending.
New Residential Construction
A monthly report on the construction of single-family homes and apartment buildings. When new residential construction is robust, purchases of household furnishings and appliances tend to quickly follow.
A monthly report of the number of previously constructed homes with a closed sale during the month. Existing-home sales make up a larger share of the market than new-home sales and indicate housing market trends.
A monthly report of the number of newly constructed homes with a committed sale during the month. The level of new-home sales is an indicator of housing market trends.
A monthly measure of the dollar value of new construction activity. Construction projects contribute significantly to gross domestic product.
A monthly report of the dollar value of product inventories held by manufacturers, wholesalers, and retailers. Included in the report is the number of months it would take to deplete existing inventories at the current rate of sales, which is an important indicator of the near-term direction of production activity.
A monthly measure of the changes in quantity of physical materials and items produced in the manufacturing, mining, and utilities industries. Industrial production is a significant indicator of trends in the industrial sector.
ISM Manufacturing Index
A monthly indicator of overall factory-sector trends, based on a survey of purchasing managers at several hundred manufacturing firms in a variety of industries. An index reading above 50 indicates that the manufacturing economy is generally expanding; below 50, that it is generally declining.
ISM Non-Manufacturing Index
A monthly indicator of overall service-sector trends, based on a survey of several hundred purchasing and supply executives in a variety of nonmanufacturing industries. A reading above 50 indicates that the nonmanufacturing economy is generally expanding; below 50, that it is generally declining.
GENERAL ECONOMIC INDICATORS
Leading Economic Indicators
A monthly composite index of ten economic indicators that typically lead overall economic activity. The index includes indicators such as housing permits, new orders for consumer goods, consumer expectations, and performance of the S&P 500 Index.
Consumer Price Index (CPI)
A widely followed indicator of inflation. The CPI is a monthly measure of the average change over time in the prices paid by urban consumers for a fixed market basket of consumer goods and services. The “core” CPI excludes food and energy prices, which account for roughly one-quarter of the broad CPI and tend to fluctuate widely, providing a truer reflection of inflationary trends.
Producer Price Index (PPI)
A monthly measure of the average change over time in the selling prices of a fixed basket of goods by stage of production, industry, and commodity. It is considered a leading indicator for consumer inflation. The “core” PPI excludes food and energy prices—which account for roughly one-quarter of the broad PPI and tend to fluctuate widely—providing a truer reflection of inflationary trends.
Gross Domestic Product (GDP)
A quarterly record of the country’s economic health. GDP represents the total value of the country’s production and consists of purchases of domestically produced goods and services by individuals, businesses, foreigners, and the government.
The role of these reports
A generalization can be gleaned from these reports evaluating them as favorable, mixed or unfavorable. Assuming favorable chart technicals and an average risk-tolerance, a favorable overall market assessment would lead us to select out-of-the money call options or put options that are closer to at-the-money than out-of-the money strikes. Both represent more aggressive option-selling positions. If our overall market evaluation was less favorable, we may opt for in-the-money call options and deeper out-of-the-money put options, both more conservative approaches to option-selling.
Accessing the information
Each week I summarize the weekly economic reports at the end of my blog articles and page 1 of our Premium Stock Reports. We also publish the overall market assessment of Investor’s Business Daily and that of Dr. Eric Wish, a Professor at The University of Maryland who teaches an honors finance course. His GMI indicator is a fabulous resource for overall market evaluation. This, of course, is in addition to the market appraisal of BCI as shown in the screenshot below and at the end of this article:
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Saturday February 28th 12 to 12:45 PM
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Retail sales (a report of the dollar value of sales of a broad range of goods, from cars and gasoline to furniture, food services, and clothing. Retail sales are a major indicator of consumer spending trends, accounting for a substantial portion of total consumer spending and aggregate economic activity) dropped by 0.8% in January the second consecutive monthly decline according to the Department of Commerce. A dip of 0.5% was anticipated. A major factor in this slump is lower gas prices. Sales, however, did increase for food and beverage-related businesses as well as for auto dealers
Year-over-year, retail sales increased by 3.3%
According to the Commerce Department, business inventories ( a report of the dollar value of product inventories held by manufacturers, wholesalers, and retailers. Included in the report is the inventories/sales ratio, a gauge of the number of months it would take to deplete existing inventories at the current rate of sales, which is an important indicator of the near-term direction of production activity) rose by 0.1% in December, slightly below the 0.2% expected
For the week, the S&P 500 rose by2.0%.
IBD: Confirmed uptrend
GMI: 5/6- Buy signal since market close of January 23, 2015
BCI: Cautiously bullish using an equal number of in-the-money and out-of-the-money strikes. This was a positive earnings season overall
Wishing you the best in investing,
Alan ([email protected])
The Weekly Report for 02/13/15 has been uploaded to the Premium Member website and is available for download.
This week’s report incorporates Stock Scouter ratings dated 02/13/15. We are receiving bi-weekly Stock Scouter ratings directly from Verus analytics, the provider of the Stock Scouter rating system. They have told us that they are in active discussions with another publisher but do not have an estimate when the ratings will be available online. We will update you as soon as theStock Scouter ratings are publically available.
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 BCI YouTube Channel link is:
Barry and The BCI Team
I wanted to describe a trade I made as an example of reducing cost basis. On December 23, 2014, I purchased 100 shares of CAVM at $63.42 and sold the Jan 15 65 Call for $1.69. Shortly thereafter the company announced it was issuing additional shares for $58 per share. The share price went down and remained near $58.
On 1/5/15, I was able to buy back the call for .21. On 1/8/15 I sold the Feb 15 $65 call for $1.65. My purpose was to try to bring in more income and reduce cost basis. Unfortunately, I did not realize that there was an earnings announcement on 1/29/15. Fearing that the stock would fall after the earnings announcement, I bought back the call on 1/26/15 for $1.30. Still a small profit.
Earnings beat expectations slightly but it took over a week for the stock price to rise to the $60 area. On 2/10/15 I sold the Mar 15 $60 call (in the money slightly) for $3.40.
If I calculate correctly, I have reduced my cost basis to $58.19.
Even if I am called away at $60 my profit is $181. I consider this a remarkable result through the use of options considering I could have lost between $300 and $500.
Thanks for the teaching the techniques like hitting a double.
Your math is spot on. You generated a net option credit of $6.74 and net option debit of $1.51 for a net credit of $5.23. This lowers your cost basis from $63.42 to $58.19.
More importantly, this series of trades demonstrates how the skill set of position management can elevate returns to the highest possible levels.
Thanks for sharing this and continued success.
Alan as I’m working through this strategy I have noticed that I’m getting higher premiums if I open my positions 45 days before expiration. These are good stocks and I’m following the rules open interest within .30 of the bid ask technicals look positive or even mixed. My thought process is if I open early I expose myself to more risk in the sense the stock has more time to move against me what do you think?
I agree with your concern. You are generating higher returns because you are entering your positions with more time to expiration, in essence, getting paid for undertaking more risk.
Time decay is known as theta and theta will deteriorate option premiums logarithmically, not in a linear fashion. This means that you will lose less premium in the first third of that 45-day period than in each of the next two.
Another factor is that when expiration occurs, what do you do with the cash or shares still owned…outside of the stocks that are part of the expanded weekly program, you are forced to use a 1-month or 2-month option unless you let the cash sit in your account for 15 days which is defeating the goal of higher returns.
Monthlys have always worked best for me but we do have members who are doing well with weeklys also.
This may be in your book but do you ever buy the security on a down day or when indictors suggest an oversold position? and then wait to sell the covered call when the stock recovers to increase the premium? or do you always use legging in or buy write to execute the transaction?
p.s. have been looking at IBD very informative taking a course on can slim and leaderboard
in Dallas Tx $99.00 I’m sure I’ll learn a lot.
I admire your motivation to master the skill of self-investing. You’re a true Blue Collar investor!
In my view, there are way too many factors that prevent us from timing the market (in the short run) on a consistent basis. They include not only company-related factors but also those related to the US economy and globally as well. What we can do is dramatically throw the odds in our favor. Therefore, I trade based on the current status of the stock price and option value. If the “deal” is there, take it. Then we go into management mode (see Gregory’s comments above).
You have 20/10 rules when stock price goes down. How about the rules when stock price goes up? for example, if i the stock I buy goes up way over the strike price in the first week, what is the rule to buy back option and sell the stock so I can use the fund to do other deals to maximize the return?
I call this strategy the “Mid-contract unwind” exit strategy. It is most often used in the first half of a contract when the time value component of the option premium approaches zero. Options tend to trade @ parity (intrinsic value only) the deeper in-the-money they move. As a guideline, if the option credit in the new position is significantly more than any cost to close the first position, using this strategy makes more sense.
See pages 264 – 271 of the Complete Encyclopedia…for more details and examples.
I have been following Cerner ( CERN ) for quite some time and I have a question. CERN did not pass the Fundamental /Technical screen this past week. Could you give me your insight as to why CERN failed this screen.
Thank you for your consideration and keep warm.
CERN is a great stock that is frequently on our Premium Stock List. If you check page 4 of this week’s report (see screenshot below), it just missed passing our rigorous screens by failing the Fundl/Techncal screens or IBD SmartSelect screen. Here, we require 6 green circles in the 6 categories and CERN had 5 greens and a yellow. This does not mean that it is a bad candidate…just one that didn’t meet our rigorous series of screens required to earn their way onto our Premium Stock List.
CLICK ON IMAGE TO ENLARGE & USE BACK ARROW TO RETURN TO BLOG.
CERN’s Group RS metric was “yellow”…dod not pass this item in the screening process.
I watched the 8 video lessons on Writing Covered Calls. I am very impressed with your articulate and lucid lessons. I will have to watch them again to master your teaching.
Before I sign on to your Premium Service, I wanted to know the mechanics of trading options on the website. I have recently opened an account with TradeStation. Do you have any suggestions for me where I can practice “paper” trading? I have traded in equities only and have no experience at all in options trading. I wanted help to walk me thru the steps.
Also can I not trade in Equities only using your “Running List” ?
Thank you for your time to reply to my questions.
I love Ellman’s information and I will be signing up today. I will give you my take on how I would use his list but Alan will be more articulate.
I am well versed in options and equity trading and his system. I look at his premium service as an excellent way to trade options and will eliminate a lot of work on my part. I still believe- based on my system- I need to review the CHART PATTERNS to make an intelligent decision. As I trade covered calls using the one strike out and one month out philosophy, I want to own a stock that has appreciation potential. since Alan’s list starts with the IBD 50 plus others he adds, I believe it is a good list which can be sorted to find the best pure equity plays as well. I couple what he does with my own trading plan. Therefore I get the best of both worlds.
I don’t believe you will go wrong with Alan’s service. It is cheaper than a Starbucks coffee and will give you better returns. Just my two cents.
I totally agree with your observation, re: looking at chart patterns before you place a trade. Charting and Technical Analysis are primary skills you need to master
Alan, I was reading an article from ‘moneyshow.com’, from a rather clever analyst called Tom Asprey, where in it he had mentioned that he will not buy a stock that is more than 3-4% above the 20dEMA.(because of a high chance of a price pullback.)
Does this sound like a good idea for buying any new stocks, or don’t you think it matters?
Some other remaining questions I had about the use of Open I. and Beta before and during trading:-
1. First just wondering why the premium report lists stocks that have got no open interest?, – are we to keep these ones on a watchlist, and then come trade time see the options chain for these stocks (that say “no open interest for ATM strike”) just in case the B/A spread is 0.30c or less, which would then make it qualify?
2. If I am already in a stock and want to make a trade and see that there is too little open interest and more than 0.30c for the options spread, then how am I to put on another trade?
3. Also if I am already in a position and want to maybe rolldown or hit a double, then should I need to check the new beta value, so for me to know what strike to use?
Really just needing a bit more clarity about using this data for the moment. Thanks
Our screening system is set up for short-term option selling only. A stock trading above its 20-d EMA with bullish MACD and stochastic signals is precisely the type of stock I want on my watch list. If I were evaluating for a different strategy like a longer-term buy-and-hold portfolio I would use different parameters.
We do not eliminate stocks based on option liquidity as of 4 PM ET because that can change. I would avoid any option with zero OI.
If you are in a position with a wide b-a spread, see if you can leverage the Show or fill Rule to execute at a more favorable price. Also, think ahead…what if I have to buy back the option? Will the spread as it stands now allow for an overall favorable result?
I consider beta a secondary factor. Primarily I am concerned about overall market assessment, chart technicals and personal risk-tolerance when making exit strategy decisions.
in your experience when selling the otm covered calls do you find that you get assigned more often than not?
Too many factors are involved to give you a meaningful blanket answer. Here are some:
1- How far OTM? The further out, the less likely is exercise.
2- What are overall market conditions? The more bullish the market, the more likely is exercise.
3- What is the implied volatility of the option in relation to the strike price? Higher volatility stocks close to the strike are more likely to be exercised.
Using some of these principles, one can manipulate a portfolio to be less likely to be assigned.
I have a question about the screening of eligible stocks listed in your weekly stock screen.
Sometimes up to 50 stocks or more are listed as candidates which pass your screen.. Although these stocks pass your rigorous criteria it is difficult for me to select the best performers. For example which of the stocks produce a better than 2% at the money monthly call premium?
You ask an excellent question.
The Premium Watch List is designed to be tailored to the needs and trading styles of each individual investor. A $200 stock may be appropriate for some portfolios and not for others. A high beta stock may appeal to some and not to others. Some members want dividend-yielding stocks, etc.
Recently, we have had several weekly lists with a higher-than-normal number of eligible candidates. So how do we select? Some members prefer the stocks in bold- the ones with the strongest technicals. Another technique is to favor those with industry ranks of “A” Price may eliminate certain stocks as well.
To check for option returns, we must check the option chains because those stats are in a constant state of change. High-beta stocks tend to have high implied volatility and therefore higher premiums but that is not always the case.
First establish a set of criteria as I described above or other criteria important to you and then check the option chains of those select candidates. The reports have a huge amount of information that ultimately can lead to a high-quality portfolio of option-selling candidates
I have been watching your videos trying to educate myself on selling covered calls. I don’t have much money to invest so I am looking at low priced stocks that are in the 2 and 3 dollar range. 2 stocks that I have been watching are aro and live. Do you have any advice on whether or not writing covered calls on either or both of these stocks would be a good choice ?
Let me congratulate you on your motivation and taking action to learn how to self-invest. Having started the learning process means you have taken the first and most important step. That process should continue and does not need you to take immediate action to start investing your hard-earned money.
One of the very important requirements for successful option-selling is to be properly diversified. When using stocks this means 5 stocks in 5 different industries, minimally. You must own at least 100 shares of each position. Using exchange-traded funds (ETFs) is a way to enter this strategy at a lower dollar investment but a $10 -$15 investment is still required.
One approach (and this is not specific financial advice but generalizations) would be to build a portfolio for future option-selling by dollar-cost averaging into a low-expense ratio broad market index fund until your account grows to an appropriate size.
You may want to consider my book “Stock Investing for Students” that details such a plan.
Take your time and continue the education process…good things ahead for you.
Chrissy, make sure you google a search phrase like “risks of dollar stocks.” You’ll see many articles that conclude they are considered more difficult to trade and riskier so not recommended for beginners.
I’d also suggest to make sure you trade with the trend for covered calls, i.e., a clear uptrend. if you pull up two-year weekly charts of ARO and LIVE I’m doubtful you’d consider these to be in an uptrend. So while they might go up, planning for a counter-trend trade is pretty risky also.
I think Alan’s suggestion of building up some cash so you can later do some higher-prices stocks makes a lot of sense. In the meantime, place a dozen paper trades every day so you can get a lot of practice. Then when your account gets larger you’ll be ready to go.
Your ideals in life are very noble.
Why don’t you have a paid service recommending stocks/ options to invest in – when to buy and when to sell ?
I’d be interested to hear your views.
There are a myriad of factors that determine the appropriate makeup of an investors portfolio such as cash available, personal risk-tolerance, market assessment, goals etc. I trade differently in my accounts than I do in my mother’s account.
To assist investors on an individual basis would dramatically limit the number of retail investors I can reach. It would also become a “job” I don’t want a job. I love what I do and look forward to every day that folks like you are interested in reading or hearing what I have to say. I am humbled by your suggestion but feel that education is the most meaningful way I may have some type of impact on average retail investors.
My info shows VRX with earnings on 2/24. Should it be on the list?
We break down earnings report dates by contract month. We are currently in the February contracts (through Friday). Stocks highlighted in the yellow cells all report during the current month. Have a look at the “running list” Stocks SERV through TSM report during the March contracts and are delineated by the broken black line and so on. VRX reports during the March contracts and will appear in the yellow cells next week if it meets system criteria
This week’s 6-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.
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Alan and the BCI team
Dear fellow investors,
As anyone who has ever corresponded with Alan knows he cares deeply about our success and has a passion for what he does.
I retired two years ago, became a Premium Member and started a dialogue with Alan that goes on to this day. He is a busy guy with a demanding schedule. But he always gets back to me. I am by no means suggesting you clutter his in box :).
What I am suggesting is if you read his books, his generous free material on this web site and start down the path of option selling you will be smarter than 9 out of 10 investors at any given cocktail party. That tenth guy will be you!
Is it perfect? Of course not. Will you get rich overnight? Never. Buy a lottery ticket if that is your dream :)!
But you can create a dependable cash flow in retirement accounts that far exceeds reliance on dividend and interest payments alone using Alan’s methods. I do it every month. And I am no Einstein.
If you ever want to see a fee based Investment Advisor start stuttering and sweating tell them you manage your own money and use option credit strategies to generate your monthly income instead of interest rate sensitive bond funds, dividend stocks or REIT’s. They may melt down right there in front of you! – Jay
paper trading on think & Swim
on 02/13/2015 bto 2000 shares fb $75.50 sold march 75’s $2.77 today 19 Feb rolled up
to the mar 80’s btc the 75’s for 5.40 sto the 80’s for 2.40 stock is above 79$ my thinking was
to participate in the stock rise does this seem like a smart move?
what other strategies would you have done?
It is important to identify your goal and prepare for potential management opportunities. You generated a 3% return with no upside since you sold an in-the-money strike. So far, so good. By rolling up in the same month you then left yourself with a net option debit of $33/contract ($540 – $517). You are up on the share side but now depend on the price holding or appreciating for a positive outcome.
Had you not rolled up, your 3% return would have huge protection down to the $75 strike.
Another approach (one that I would prefer) is to watch the time value component of the $75 call during the March contract. If it approaches zero, close the total position and re-enter a new position with a new stock to generate a second income stream. This is our mid-contract unwind exit strategy found on pages 264 – 271 of the Complete Encyclopedia…
Bruce, be very careful about paper trading accounts because most of the time they do not exercise your expired options and leave you with the illusion you keep both your stocks and your premiums. This can lead you down a dangerous path of over estimating your returns.
The real world works differently. Today was expiry. FB closed at $79.89. If you were playing in the real world and had written any calls at strikes below that your FB would be called away tonight. Which may or may not be a bad thing.
My experience with paper trading virtual accounts is they may not call your FB shares. So just watch them to make sure they behave like real accounts. All the best, – Jay