In the BCI methodology for covered call writing we use predominantly 1-month options. There are times, however, where we find cash in our accounts (mid-contract) that is inactive. This may be due to closing a position early either because the share price declined significantly or accelerated exponentially. Perhaps Grandma gave you a generous birthday present. Whatever the reason, the question arises should we enter a new covered call position mid-contract? Some may elect to wait until expiration Friday and enter new positions all at the same time for the following contract cycle. My personal preference is to keep my money working full time except in extreme market declines (2008). This article will discuss one way to approach mid-contract covered call positions. The stocks mentioned are NOT necessarily recommendations but rather displayed for educational purposes.
When selecting appropriate underlying candidates mid-contract we use the same system criteria as we do for full month trades: Elite performers fundamentally and technically while also screening for the “common sense” BCI requirements (no earnings report etc.). Therefore, we initially turn to our watch lists (premium or the one you developed). There are two major differences I employ when entering these mid-contract positions:
1- My goal changes from 2-4% to 1-2% for the remianing two weeks
2- I will favor in-the-money strikes in MOST market conditions because exit strategy execution becomes more challenging the closer we get to expiration Friday so I like the addition protection of ITM strikes. In strong bull markets I would have no issues going with the more aggressive OTM strikes.
This past week I received a few inquiries about this topic so it led me to this week’s blog article. On Thursday evening, May 3rd I accessed our recent premium report and went straight to the “running list”. I then went to an options chain to see which candidates would meet the following goals:
1: 1-2%, 2-week return
2: Decent downside protection of that profit
Here is a partial view of that running list with a few stocks that I would consider:
- Running List
The yellow-highlighted cells are candidates worthy of entering into the Ellman Calculator based on option chain information. I then entered the potentially eligible stocks into a spreadsheet, including option chain information and industry information (remember that we must be properly diversified). Here’s what that looked like:
Options chain information
Next the information is fed into The Ellman Calculator where will look for our goal of 1-2%, 2-week return WITH protection. Below is a screenshot of the results:
- Ellman Calculator- Multiple Tab
In the green-highlighted cells I have selected 5 stocks in 5 different industries that best meet these goals. If I were looking for only one or two equities, the two circled in red would be given strong consideration.
Conclusion:
Entering a covered call position mid-contract does make exit strategy execution more challenging but not insurmountable. It has the advantages of putting your money to work more frequently but requires a change in return goals and an adjustment of your strike selections. A well-formed watch list should provide a suitable number of choices to select from.
Live events update:
May 8th: I will be the keynote speaker for the Long Island Stock Traders Meetup Group. I will present a basic review of covered call writing and then proceed with an audience participation section where your favorite stocks are analyzed for potential covered call trades:
Place: Plainview-Old Bethpage Library (Auditorium)
Time: 7 PM – 9PM
Admission is FREE and non-members are welcome.
June 12th: I will be the keynote speaker for the New York City Private Investors Group at the ING Direct Cafe:
Time: 6PM to 7:30 PM
Admission is FREE and non-members are welcome.
NEW MEMBERS:
We invite you to take our FREE video beginner’s tutorial with FREE powerpoint downloads:
Market tone:
This week’s mixed bag of economic reports came out over the backdrop of concerns that the euro zone’s recession may be deeper and longer than anticipated. This concern intensified after reports that their service sector index fell to 46.9 in April compared to 49.2 in March:
- A disappointing jobs report caused the market to plummet on Friday as 115,000 new jobs were created lower than the 165,000 expected
- Temporary hiring increased, however, after falling in March
- The unemployment rate declined to 8.1% from 8.2%
- Nonfarm business activity (measure of economic efficiency) declined at an annualized rate of 0.5%, in line with expectations
- The ISM’s nonmanufacturing index fell to 53.5 from 56.0 worse than the 55.0 expected. A reading above 50 signals expansion so economic activity continues to grow but slower than desired
- The ISM’s manufacturing index rose more than anticipated in April to 54.8 (53 was the expected stat)
- Construction spending rose by 0.1% in March, less than the 0.5% expected. This was due to a decline in government spending. Private sector spending actually increased by 0.7% mainly due to new single family homes
- Consumer spending increased by 0.3%, lower than the 0.4% anticipated
- With about 80% of S&P 500 c0mpanies having reported earnings recently, 67% have been positive surprises while 24% have been negative surprises. This is a critical component to the bullish stance taken by this site over the past 9 months
For the week, the S&P 500 declined by 2.4% for a year-to-date return of 9.6%, including dividends.
This site has been generally bullish on the economy and our overall covered call positions since last September but more recently has taken a defensive stance. As previously explained this is due to the volatility the markets have been experiencing:
- Market tone: 5-4-12
Please note the following:
- The S&P 500 (blue line) is up about 2.5% in the past 3 months, a stat we can live with
- The VIX (black line) looks like it just took a ride on the Space Mountain roller coaster ride @ Disneyland
- In the past 3 months the VIX has been up by 20% and down by 20%
Summary:
IBD: Market in correction
BCI: Cautiously bullish using predominantly in-the-money strikes
My best to all,
Alan ([email protected])
Alan,
With one week remaining would you still try to enter a new position?
Thanks.
Ted
Ted,
Generally, the time value of most options has eroded to the point where entering new covered call positions in the final week of a contract generates very little profit and makes exit strategy execution extremely limited. I usually wait for the next contract cycle. We do have many members interested in weekly options (the number of these products has been increasing as the demand intensifies) and our BCI team does plan to provide information in this area as we expand and move forward. Most of our members should focus on the 1-month options.
Alan
Alan,
I just joined and I’m really excited about learning about stocks and options. I’m curious how you decide how many shares of stock to buy. I’m planning to start (paper trade first I know) with about 75,000 and 5-7 stocks.
Thanks for sharing all this information.
Susan
Susan,
We try to keep our cash allocation as evenly distributed as possible. If you have a portfolio of $75k and 5 stocks, try to allocate approximately $15k per equity keeping in mind that you will need to maintain a cash balance of 2-4% for exit strategy execution.
Take the price per share and divide it into $15k and round to the nearest 100. You may have to adjust one of your positions if you go over $75k or if you don’t have adequate reserves for exit strategies.
Alan
Premium Members,
The Weekly Report for 05-04-12 has been uploaded to the Premium Member website and is available for download.
Best,
Barry and The BCI Team
Another prospect from this weeks list is ASNA:
2.2% 2 week return with 2.2% protection. For the 21.50 call.
Fred
Alan,
I need to go over some questions that I had emailed you a little while ago. – First you said that you prefer daily charts, but would this be the only type you use? (I have been thinking of using technical analysis on 3 multiple time-frame charts of the Weekly ,Daily, and Hourly ones, because I have read in a trading book that we should get a better picture of the trends than just 1 chart.) ?
– Do you think these ones above are the correct charts for me to use?
– And if I wasn’t to look at the premium reports(at trade time) for seeing the industry ranking, then would I have to see the industry(or sector) chart in this case?
Thanks for your help with all this.
Adrian,
The selection of technical parameters is an individual preference and should be based on the type of investing you are using. For me, daily charts are perfect for writing 1-month covered call options. For longer or shorter-term investing I would select different time frames.
If you didn’t have the premium report to reference when making your investment decisions I would definitely view an industry chart or have access to the industry rank to make sure that the sector is favored by the institutional investors.
Alan
Alan –
Just as markets open every morning, the option contract prices recalculate, sometimes drastically. With that in mind, do you set up your “sell to open” and or “buy to close” actions with your broker the day before and see what happens the next morning, or do you wait until after the markets open and then put in your bids?
Thank you ~ Becky
Becky,
STO and BTC orders are placed at the time the trade is about to be executed for the very reasons you alluded to in your inquiry. An exception could be after entering your total cc position, some members who subscribe to my 20%/10% guidelines will place a BTC order in preparation for potential exit strategy opportunities. Generally, calculations and order placements should take place just prior to trade execution.
Alan
Premium members:
At the request of some members we have just completed publication of our ETF User Guide. It explains the different aspects of the report and a few ways to implement your covered call positions using these securities. The guide has been uploaded to your premium site in the “resources/downloads” section.
Alan
Alan,
As you say that you only use daily charts, I am still thinking that I will (at least at the start of my trading) use all the 3 charts of weekly,daily, and hourly period ones. If I were to get better at selling covered calls then I may just then use daily charts on its own!
I just feel a bit more confident seeing a bigger picture chart, as well as using a smaller one to time trades also, even though I don’t really know if I need to time trades with covered calls.
Also I had already read 2 trading books that describe this multiple time-frame analysis (and was actually the reason I got them), so now I am thinking that I should at least try it.
Oh well, maybe some day I could save some time and not have to see all the 3 charts!!!
I will post some questions soon about using the indicators on them;- and I had left another last lot of questions under ‘VIX’ heading which would help me quite a bit if I knew the answers. thanks
Adrian, I think about charts, MAs, indicators, etc kind of like how I thought about issues at work. If there was a clear action or even a probable action to be taken as a result, then it’s a good thing to review. If not, it’s a time waster at best and possibly something that creates confusion. Maybe the question here is what actions will you take with the three different sets of data that is different than if you’re only looking at one? For example, would you only buy a stock if they all three agree? That’s actionable. Or said differently, what trading rules do you for when they don’t all agree? That might convert it from a nice-to-know into something actionable. Steve
Thanks to all our members who attended my presentation last night in Plainview, NY. It was great seeing you and I hope to see you in my NYC presentation in June.
Alan
Hi steve, thanks for your comments. From the way you wrote it sort of sounds like we could be wasting our time looking at 3 chart periods, then just using the the daily chart as alan does.
I am still learning everything, but from what I have read the multiple time-frame analysis seems a much safer approach to buy/sell shares or options, than just using 1 chart. The only thing I can think of for maybe not needing more charts, is when I read that for selling covered calls we don’t need to be so accurate with the entries/exits, then to other trading strategies.
Can I just ask you, are you selling CC’s presently?, and if so then do you use any more than the daily chart for putting on trades? (if you would then would this be for just the shares you hold, or for index, & possibly the industry too?) thanks
Adrian, I am selling CC’s presently. I’ve been using an “overwrite/OTM” strategy on dividend paying stocks for about a year now and I’ve also been using Alan’s method since the first of the year. I only use the daily chart.
I think looking at weekly and monthly charts can sometimes be informative when you’re looking at the overall market trend. I have more trouble seeing the value for a one month trade on an individual stock.
As I mentioned previously, if you look at all three timeframes before doing a CC trade, how do you use the information? If the daily looks good but the monthly or weekly doesn’t do you pass and go on to the next stock? If yes, then you basically have a rule that you’ll only enter a trade when all three agree. I could live with that as it’s actionable and adds another degree of conservatism to the trade decision. That may be good. But without some specific rule for how you’ll use the three timeframes, I’m not sure how you make it consistently actionable.
Hi Alan,
I really enjoyed your presentation onTuesday. You mentioned an SEC rule you used when placing your bid offer. Can you go over that again.
Thanks for sharing this information.
John
John,
I’m glad you could make my recent seminar. The rule you are alluding to called the “Limit Order Display Rule” or the “Show or Fill Rule”. It is an SEC regulation that market makers must publish orders that “improve” the current bid-ask prices unless filled. I mentioned it when we came across wide bid-ask spreads and suggested we enter our bid orders at slightly below the mid-point. For example, for a bid-ask spread of $2.50-$3.00, I would look to generate $2.70. For most equities it would apply for orders of 10 contracts or less (more in some cases) and remember NOT TO CHECK THE “ALL OR NONE BOX” on your trade execution form. For more information, see pages 225-227 of “Encyclopedia…”
Alan
Premium members:
This week’s 6-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site.
***At the request of our membership we have written and published an ETF User Guide located in the “resources/downloads” section of your premium site.
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
Running list stocks in the news: FIRE:
On April 30th FIRE (Cybersecurity technology) reported its 7th consecutive positive earnings surprise with revenues up 48% and earnings up 300%. The stock has moved higher nearly 4%, on average, following these reports. Our premium report shows that this equity has been on our premium watch list for 7 weeks, is in an industry with a rank of “A” and has a beta of 1.39. As a result of all this positive news, the earnings estimates have been on the rise as shown in the chart below (click on chart to enlarge and use the back arrow to return to this blog):
Alan
A replay of a radio interview is now being re-broadcast:
http://www.thebusinessauthorsshow.com
BCI Community,
It is with great pleasure that I am proud to announce that Alan Ellman has reached another level in his distinguished career. He has just become a grandfather. Please join me in welcoming Seneca Wade Ellman, weighing 7 lbs, 1oz., to the world. All of the Ellmans…Mom, Dad, Seneca, Alan, and Linda are doing great.
Respectfully,
Barry Bergman
Alan, congratulations. My first grandchild is due in December. I’m excited so I’m sure you are too. Steve
Fantastic! Was blessed with our first two years ago, and they are angels.
Cobgratulations!
Thank you Jerry. It doesn’t get any better than this! Thanks also for all the off-site emails of congrats. I’ll be posting my “bragging photos” when I return to NY.
Papa
Alan
I stayed on the side lines this month for an assortment of reasons – maybe I was lucky. With one week to go and I want to get back in – do I buy next Friday or next month?
Frank,
I will normally wait to expiration Friday or early the following week. You will lose almost no time value and have an additional week to evaluate your positions.
Alan