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Establishing a Blue Chip Covered Call Portfolio

Covered call writing and selling cash-secured puts are strategies that can be crafted to meet the personal risk tolerance of all investors. I use stocks selected from our premium watch lists in my accounts and from the ETF Reports in my mother’s account. Recently, several members have asked about using only blue chip companies. These are defined as nationally-known, well-established and financially secure corporations. As a result of these inquiries the BCI team is providing quarterly reports of the best-performing Dow 30 stocks from 3-month and 1-year perspectives. In this article, we will use the 10 best out-performers to create a portfolio for covered call writing using out-of-the-money strikes taken from the 8/20/2016 report…premium members should use the most recent monthly report.

 

Blue Chip Report of 8/20/2016 (top section)

 

covered call writing with blue chip stocks

Blue Chip Report from 8/20/2016

 

Selection process- basic approach

Add up the prices-per-share of all 10 candidates and multiply by 100. That will be the cost to buy 100 shares of each and sell 1 option contract per security. Now take that amount and divide into the cash available. In this example, if we had $300,00.00 cash available we could purchase 300 shares of each stock costing $264,273.00 plus commissions.

 

Selection process- advanced approach

In this procedure, we calculate the average cash per position. For a portfolio of $300,000.00 and 10 stocks, we would dedicate approximately $30,00.00 per position. Next, we divide the price-per-share into $30,000.00 and round of to the nearest 100. For example, we would buy 1000 shares of CSCO ($30.52) and 200 shares of MMM ($179.61). Adjustments may need to be made to assure an adequate amount of cash available for potential exit strategy opportunities.

 

Calculations if we purchased 300 shares of each stock: The Ellman Calculator

calculating covered call returns

The Ellman Calculator: Multiple Tab

Results show initial 5-week premium returns of 1.52% with upside potential returns of an additional 1.99% This creates a scenario with a possible 5-week maximum return of 3.51% which annualizes to 36.5%

 

Discussion

Option-selling can be tailored to one’s personal risk tolerance. Using blue chip stocks only as the underlying securities is a conservative approach to covered call writing. Generally, returns will be lower than those from our main premium watch list but still formidable. A secondary benefit is that these securities also offer dividend distributions which can enhance returns even higher.

 

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1- March 21st and 22nd, 2017

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2- April 12, 2017

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Recently added:

March 2, 2017 (next year): POINT Options Group Phoenix Arizona

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Market tone   

Global stocks continued to rise this week, and strong global manufacturing data continued to improve. Despite growing economic optimism, oil prices fell this week on increased US inventories. Volatility remains subdued, with the Chicago Board Options Exchange Volatility Index at 10.96. This week’s reports and international news of importance:

  • The week began with markets pricing in about a 50% chance of a hike in the federal funds rate at the Federal Open Market Committee meeting this month but ended with markets almost fully pricing in a quarter-percent hike. Comments from Fed chair Janet Yellen helped seal expectations of a March hike
  • A rise in the ISM manufacturing purchasing managers’ index and a jump to a 15-year high in the Conference Board’s consumer confidence measure were two standout data points in the United States this week
  • China’s PMI showed strength as well, though the eurozone’s and United Kingdom’s PMIs were less robust
  • Economic sentiment in the eurozone reached a six-year high
  • The Eurozone data reflected an energy-driven rise in inflation to near the European Central Bank’s 2% target. This is the first time consumer price inflation has reached the target in four years
  • The Dow Jones Industrial Average closed above 21,000 for the first time on Wednesday, while the S&P 500 Index reached 2,400London’s FTSE 100 also closed at a record high on Wednesday, supported in part by a weak pound.
  • Despite suffering a defeat in the House of Lords over the Brexit bill, UK prime minister Theresa May insists her timetable for triggering Article 50 will not be delayed
  • With 98% of companies reporting for the fourth quarter of 2016, the earnings growth rate for the S&P 500 is 4.9%. The 4th quarter will mark the first time the index has seen year-over-year growth in earnings for two consecutive quarters since Q4 2014 and Q1 2015

THE WEEK AHEAD

MONDAY, March 6th

  • Factory orders Jan.

TUESDAY, March 7th

  • Foreign trade deficit Jan.
  • Consumer credit Jan.

WEDNESDAY, March 8th

  • ADP employment Feb.
  • Productivity Q4
  • Wholesale inventories Jan.

THURSDAY, March 9th

  • Weekly jobless claims

FRIDAY, March 10th

  • Nonfarm payrolls Feb
  • Unemployment rate (U3) Feb.
  • Federal budget Feb.

For the week, the S&P 500 was up by 0.67% for a year-to-date return of 6.44%. 

Summary 

IBD: Market in confirmed uptrend

GMI: 5/6- Buy signal since market close of November 10, 2016

BCI: I am currently fully invested and have an equal number of in-the-money and out-of-the-money strikes. Cautious, concerned and hopeful…waiting for the math to add up relating to new administration promises and how they will be paid for. I need both sides of the equation to balance out in order to become more aggressive.

WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US

The 6-month charts point to a slightly bullish outlook. In the past six months, the S&P 500 was up 9% while the VIX (10.96) declined by 9%.

_____________________________________________________

Wishing you the best in investing,

Alan ([email protected]) and the BCI team

 

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

14 Responses to “Establishing a Blue Chip Covered Call Portfolio”

  1. Roni March 4, 2017 3:51 pm #

    Hi Alan,

    Excelent article !!!

    For me this is a great idea.

    My limited risk tollerance and minimum 2% ROO for monthly premiums, was keeping me away from blue chips.
    Now I see the advantage when upside potential is added.

    I am planning to increase my trading funds next month, and establish a Blue Chip Covered Call Portfolio.

    Tks – Roni

    • Jay March 4, 2017 9:59 pm #

      Roni,

      Blue chips make increasing sense to me for covered call writing. As you get more into it please also try a LEAP as described in the Blue Hour webinar on poor man’s covered calls for comparison.

      I suggest using one of the same stocks you own to get a direct comparison over a few month’s time of return ratio versus cost. LEAPS may win an ongoing place in your batting order! – Jay

      • Roni March 5, 2017 10:44 am #

        Thanks Jay,
        I will do that.
        Must get a higher approval level from my broker first.

        🙂 – Roni

        • Jay March 5, 2017 11:23 pm #

          Hey Roni,

          Interesting you need a higher options clearance to buy a LEAP and cover it. No doubt rules vary by country and broker.

          I got a grin out of Alan’s depiction in a previous blog of risk as a line between Lotto tickets and cash :). Sorry. Alan, if I did not convey that image quite right!

          Along that line after you leave Lotto tickets are horse tracks, casinos and Bingo parlors :). Once you get to the market you hit bankruptcy sales, penny stocks, junk bonds, IPO’s, growth stocks, LEAPS, Blue Chips, preferred’s. utilities Treasuries and finally stumble home beaten and weary to cash :).

          I do not know where to place GLD because gold bugs are an opinionated bunch and I don’t want to offend anyone!

          What has worked for me is making my picks, placing them on the spectrum line of risk then selling put options on those closest to cash and buying call options on those closest to Lotto to get the ball rolling.

          These strategies have endless flexibility! – Jay

          • Roni March 6, 2017 10:08 am
            #

            Yes Jay,

            my broker is Scwab, which was the only broker handling international accounts in Brazil at the time I started in 2010.

            My approval level 2 is as follows:

            All of level 1, plus:*
            Vertical spreads
            Long calendar/diagonal spreads
            Long ratio spreads
            Butterfly spreads
            Condor spreads
            Iron butterflies
            Iron condors

            I do not know what it all means, but I traded LEAPS with same month covered calls, with mixed results, and gave up because of the multiplied ammounts on small moves of the underlying stocks.

            I was not able to place LEAP trades such as the ones indicated by Alan.

        • Jay March 6, 2017 12:04 pm #

          Thanks Roni,

          Schwab is a great house and has been a good stock for our friends here!

          Level 2 should be all you ever need. I do everything on your approved list except ratio spreads and butterflies. I do a lot of verticals, a few diagonals and condors since they seem more intuitive to me.

          I can understand your trying and forsaking LEAPS since the same leverage that attracts some can be outside the comfort zone of others. I stopped trading the 2x and 3x daily leveraged ETF’s for the same reason. Seemed they were always two steps back and one step forward.

          I’m OK with LEAPS that move pretty close to dollar for dollar with the underlying though that is still high leverage considering you buy them for half the price of the stock. – Jay

    • Alan Ellman March 6, 2017 6:13 am #

      Roni,

      Like many of the enhancements to our membership benefits package, this idea was the result of member feedback. This dialogue allows us to bring the quality of information and education that best assists the BCI community.

      Alan

  2. Barry B March 4, 2017 10:15 pm #

    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 03/03/17.

    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

    There was recently a billing with some members using American Express for premium membership. We spoke with American Express and there was a glitch in their system which has been repaired (we are told). They will be directly crediting all accounts that were double-billed. Please check your next statement to make sure you receive the credit.

    Best,
    Barry and The BCI Team

  3. Diego March 5, 2017 11:11 am #

    Hi Alan,
    I feel there’s great merit to using conservative dividend stocks and enhancing the income with Covered Calls and Cash Secured Puts to create reliable income. In my opinion only CSCO and UTX are currently fairly valued and the rest are overvalued and a few by quite a lot at their current level. The reason I think this is important is that the success of this strategy is the ability to sell options consecutively including rollouts. If the price drops this may be difficult to do above your cost basis and selling ITM Calls introduces another level of risk into a conservative strategy. What I think is a strength of the strategy is that these stocks tend to trade in a narrow range and when they are below your cost basis there’s a relatively high chance that the dividend will not be cut. So, this becomes your income until the price bounces back to your cost. My experience with a similar portfolio constructed of 25 Dividend Aristocrats is a combined income of dividends and premiums to be 10-12% realized annual income with a small positive Total Return. This creates a fairly reliable and safe income stream in retirement. The downsides of the strategy are low option volumes on these stocks (large Bid/Ask spreads) and low volatility (small premiums). It would be fantastic if you could extend the study to a full year.

    • Alan Ellman March 6, 2017 6:35 am #

      Diego,

      This new report we provide to our members reflects the best-performing DOW 30 stocks from a short and long-term perspective. Both criteria must be met. We understand and respect that some members may use these lists in other ways or even screen from different perspectives based on personal risk tolerances or trading styles. It is important to realize that we are undertaking 1-month (or 1-week in some cases) obligations. If an underlying starts under-performing, we can add a replacement from the new watch list published in the following month. Furthermore, we have our exit strategy arsenal which always is ready to launch when such opportunities present themselves. In my view, selecting the best-performers, managing based on our position management skills and re-evaluating portfolio makeup on a monthly basis is a recipe for success.

      This is with the understanding that other approaches can work as well.

      Alan

  4. Alan Ellman March 5, 2017 5:40 pm #

    Murray was kind enough to share this with the BCI community (I redacted names where there was a negative comment):

    Alan,

    I believe you will find what I am about to tell you very interesting as well as how impressed I was with your website and the fantastic offer for being a new member. I believe your members will be interested in the following.

    I paid 1,500.00 3 weeks ago for a membership with DELETED NAME (I am sure you have heard of them). They originally wanted a 4,000 annual membership but agreed to 1,500.00 because I am 71 years old, practically deaf (learned to lip read when I was 5 years old) and the eyesight is failing. In 2007 I had a brokerage account with DELETED NAME with a 2 million dollar account. I knew nothing about the stock market as I sold several restaurants that year and they were recommended to me by my attorneys. Long story short, they lost close to 700K in 2009. I then took the remaining shares that I owned, opened an account at DELETED NAME and learned how to use what money I had left in equities and sold covered calls and took me 4 years to recoup my losses. It wasn’t hard because I owned many equities such as NFLX, C, GM, CAT, DE and many more as they were at their all times lows and over the years they came back.

    I saw your video on Youtube and was very impressed with all your 8 beginning video on how to sell calls and puts as well as covered calls. You speak very clearly and explain everything in a easy to understand format as I can read your lips clearly. Very impressed with your BCI format and all the valuable information, videos, calculators and reports to make me a smarter investor. I will not be returning to DELETED NAME and consider my investment in them a loss, however with your system I made 6 trades selling puts and covered calls and made my investment back. I must tell you that I love the market and your system will vastly improve my income which at this time I don’t need any income because I am only interested in minimizing my risks, understanding the all the different strategies that I could grasp with DELETED NAME.

    I also am using OptionHouse for my trades and my costs for options are less than 40 cents for each one in and out as I have a very large account with them. By the way, my CPA informs me that I can make up to 800K without paying any taxes because of the huge losses I suffered with DELETED NAME. I also sued them and won a settlement for 150K.

    Sorry for the long email but now you know the rest of the story (Paul Harvey was my favorite).

    Murray Kellman

    (Please feel free to use me or my story as a testament to being a new and happy BCI member).

    • Jay March 6, 2017 3:26 am #

      Dear Murray,

      Welcome to our Community!

      I am one of the old buzzards around here who people tolerate like a flatulent Uncle 🙂

      I am with you on Options House. Best rates and trade execution in the game. I will never trade anywhere else.

      When you were a restaurant owner you likely had a vision of who you were, what made you tick and what made you pop out of bed in the morning eager to face a new day.

      l hope you still have that energy as an investor because it is the most liberating feeling in the world. – Jay

  5. Justin March 5, 2017 9:34 pm #

    I’ll definitely keep my money away from DELETED NAME 🙂

    • Alan Ellman March 6, 2017 6:02 am #

      Justin,

      I have a firm policy of never saying a bad word about other sites/vendors. Educated retail investors would learn to avoid and not get involved with any “DELETED NAME”

      Alan

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