Exit strategy execution for covered call writing and put-selling is the 3rd required skill needed to achieve the highest returns (stock and option selection are the other two). Knowing how and when to implement these position management trades will have a major impact on our ultimate success. In July 2020, Clark sent me a series of trades he executed with MGM Resorts International (NYSE: MGM) where several exit strategy maneuvers were utilized. This article will analyze this series of trades.
Clark’s MGM trades from 6/8/2020 through 6/21/2020
- 6/8/2020: Buy 100 x MGM at $23.18
- 6/8/2020: Sell 1 x July 17, 2020 $26.00 call for $1.54
- 6/12/2020: Buy-to-close (BTC) the $26.00 call for $0.54
- 6/12/2020: Sell-to-open (STO) the July 17,2020 $19.00 call for $2.38 (rolling-down)
- 6/21/2020: MGM trading at $17.17
Let’s break down these trades into 4 categories:
- Initial structuring
- BTC trade
- STO trade
- Exit strategy execution after the STO rolling-down exit strategy
Initial structuring
MGM Initial Calculations
Using the multiple tab of the Ellman Calculator, we see that the initial trade structuring resulted in an initial time-value return of 6.6% with an additional 12.2% upside potential, a possible 18.8% 5-week return. This reflects a tempting but highly risky trade. We should only enter trades that align with our personal risk-tolerance. My initial time-value return goal range is 2% – 4% which usually results in a similar upside potential for OTM strikes. No right or wrong here but we must define our goals and risk tolerance prior to entering our trades.
BTC trade
The BTC price point was at 35% of the original premium. In our BCI methodology, we prefer closer to 20% in the first half of a monthly contract. On 6/21/2020, the $26.00 call could have been closed at $0.10.
STO trade
The STO of the $19.00 call locked in a trade loss of $80.00 per contract (calculating share loss and option credit) if MGM closes at or above $19.00. We are still early in the contract, so after closing the short call, we can wait another week to see if share price recovers and perhaps create an opportunity to hit a double.
Exit strategy execution after the STO rolling-down trade
At this point, we set a BTC limit order at $0.45 for the $19.00 short call and manage moving forward. What’s done is done and we must focus on the positives moving forward.
Discussion
There are 2 positives here, as I see it:
1. Clark was focused on managing the trades which gives us a huge advantage over those who do not.
2. We have experienced a trade that is instructive on many levels and the lessons learned will put cash in our pocket in the future. This is precisely how I learned more than 20 years ago.
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:
Dear Alan,
Being a new member to the BCI team, I really appreciate all your insights into trading. I was always bogged down with the Put strategy and never understood until I watched your videos and bought all the books to read. This is one of the best investments that I have ever made and you are the BEST.
Thank you,
Sara
Upcoming events
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Tuesday January 19, 2021
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Hello Mr. Ellman,
I came across your tutorial, which was very helpful, so I was wondering if I could run my trade by you, to see if there is a way, I can get out this jam, I have put myself in?
I own FCEL at $10.50 for many years, it never passed $2.00 So, when it went up to $4.00, I sold 3 covered calls for $3.80, but the stock went up to 20, and the call premium went to $15.44. along the way, I have made a lot of wrongs…
So, before the expiration on Friday, Jan 15, I rolled up to April 19, for a premium of $15.44, i.e. I am at a loss of (15.44 -3.80) x 300 = 3,468
So, would it be a good strategy rolling up the strike price to reduce the losses, if so, what would be the best strike price?
I.e. keeping the expiration the same and just increase the strike price?
I greatly appreciate your input.
Thank you,
Sussan
Sussan,
I can respond in general terms without giving specific financial advice.
What happened in the past is not relevant to the trades we execute today. Taking this approach will allow us to make the best trading decisions given the current circumstances.
In the BCI methodology, we keep our contract obligations to 1 month or less in most scenarios. Having an option in place (April contract) will take us through the 1/21/2021 earnings report for FCEL, a potentially risky event.
The trade is currently structured with an out-of-the-money ($19.00) strike in place as FCEL closed at $15.84. Rolling options is usually reserved when strikes move in-the-money.
The trading decisions should be based on concern for the earnings report and evaluation of our bullish assumption of the underlying security.
Studying the exit strategy portions of my books/online video courses will provide clarity on how to manage this and all other situations that may arise.
Alan
Hi Alan,
Thank you. I do agree with you.
I did not manage it right.
Sussan
Sussan,
I would frame it differently. You had a valuable learning experience that will put cash in your pocket for years and decades to come. This is exactly how I taught myself these strategies and I couldn’t have achieved financial success without learning from and improving my trades.
Keep up the good work.
Alan
Hi Alan,
Yes. This was the first time ever to roll a covered call option. My main reason for rolling was to buy some time.
As of Friday, I have reduced my losses. I am planning to reduce the time from April to Feb. if I see the time value is favorable.
As of Friday, there was no price difference between April and February expiration.
There was one downgrade on FCEL on Friday, but still, the earning on the 20th is the main issue.
I really appreciate your follow up.
Best Regards,
Sussan
Alan
Do you also have tutorials on how to sell put options on Stocks you wouldn’t mind owning at 10 to 12% lower?
Thanks,
KM
KM,
Sure do:
https://thebluecollarinvestor.com/minimembership/selling-cash-secured-puts-basic-and-advanced-principles-2-part-dvd-series-workbook/
Also (book):
https://www.thebluecollarinvestor.com/alan-ellmans-selling-cash-secured-puts/
Alan
Thank you. I will watch them next week.
I’m looking to safely generate 4-5k a month on a 1/2 million $ account selling calls and puts. Possible?
KM
KM,
Once the 3-required skills (stock selection, option selection and position management) are mastered, this is an extremely reasonable goal to set in most market conditions.
Alan
Hi Alan,
I sold HD $270 Call expiring 01/15. Yesterday, in early hours of the trading session, HD was trading around the strike price and I decided to roll it to February contract (02/19). The credit was in $6.50-6.75 range, but the time value left was still about $0.80-0.90, so I decided to wait. During the trading day HD kept rising and 1 hour before the close it was trading in $275-276 range, so I finally rolled for $5.25 credit as the option moved ITM. Still good, but it could be better.
My question is, do you think it makes sense to take more active approach and roll when the opportunity arrises to capture the higher premium when stock is trading NTM instead of waiting the last few hours of expiration day? Sometimes such situations are in place even few days before the expiration Friday.
Sunny
Sunny,
Great question.
Theta or time-value erosion is logarithmic in nature… it starts out slowly and then “falls off a cliff” as expiration approaches. The $0.80 – $0.90 will be pennies as 4 PM ET approaches. The next-month option will not be impacted nearly as much because of that logarithmic rationale.
If the time-value is approaching zero much earlier (rare, unless strike is deep in-the-money) then rolling is okay.
Watch that 2/16 earnings report date.
Alan
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 01/15/21.
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:
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On the front page of the Weekly Stock Report, we now display the Top 10 ETFs, the Top SPDR Sector Funds, and the 4 single Inverse Index Funds. They are sorted using the 1-month performances from the Wednesday night ETF report and the prices from the weekend close.
Best,
Barry and The Blue Collar Investor Team
barry@thebluecollarinvestor.com
Hi,
I’m interested to become a member; I understand that I’ll can find the best opportunities for the covered calls but don’t understand if I’ll find also the profit/loss chart of the position and if it is possible to see the future scenario.
Thank you for your reply.
Sergio
Sergio,
Our covered call writing calculators do show initial time-value return, upside potential for out-of-the-money strikes, downside protection for in-the-money strikes and breakeven price points. No need to be concerned about the math.
Alan
Hi Alan & everybody,
You suggest the using of inverse ETF’s when the market turns bearish however in Europe, we are no longer allowed to use American ETF’s because of lack of information about them.
I was wondering if you have any alternative strategy to propose when we have to face that sort of period?
Thank you and happy Sunday!
Gaetan,
There are several approaches to dealing with bear markets outside inverse ETFs. Strike selection of the best-performing securities is a reasonable place to start. We give preference to deep in-the-money call options and deep- out-of-the-money cash-secured puts that will generate time-value returns towards the low end of our stated time-value return goal range. For example, if out goal is 2% – 4% per-month, we shoot for 2%. We can integrate both strategies using the PCP strategy where we enter a covered call trade by first selling out-of-the-money cash secured puts.
One tool I started using recently is to sell deep out-of-the-money cash secured puts with Deltas of 10 or less (-0.10) to generate annualized returns between 10% – 20%. Now, I’m back to traditional option-selling.
Alan
Great, thank you Alan!
Market looks good right now, I just would like to get ready with a structured strategy and no emotions (let’s try) for the day when Mister market will get mad, maybe tomorrow, in weeks or months… 🙂
Gaetan,
I also worry about market crash but you said it best with “get ready” and “no emotions”
Good luck to you and the entire BCI community.
Marsha
Thank you Marsha!
I think we have to deal with crash or periodic down trend, it’s part of this business 🙂
If some positions go inverse that what we were expecting, after we have done our due diligence, we don’t have to feel culprit especially because most of the time it goes through the direction we planed 🙂
++-++–+++++-=+++++!
Good luck to you too!!
Alan:
I am reading all your books I bought, made a few trades, and I am learning a lot. I have a couple of questions:
– I know you like monthly CC. But in one of your videos (the one about setting up an entire portfolio) you mentioned that if it is not the beginning of the contract month, then you use weeklies. So does that mean that since the report comes out every week that we should only be entering positions at the beginning of the next contract month? If so, then why do we get reports every week? Is that in case you have to unwind a position mid-month and want to reinvest?
– Let’s say we enter a position based on your report and it works out fine. But next month the stock is not on your report. At what point do we decide to sell that stock to generate cash and enter another position? One month, two months?
– Today the market is closed and LOGI announces earnings today. Is it OK to enter a trade for them tomorrow or Wednesday (I happen to already own LOGI from last month’s position)?
Thank you!
Don
Don,
My responses:
1. We update our stock and ETF reports weekly for several reasons. Many of our members prefer weekly options over monthly options… nothing wrong with that. If we decide to close our long stock position mid-contract, we turn to our most recent stock or ETF report for a replacement security. Also, Weeklys can be used to navigate around ex-dividend dates and earnings report dates.
2. Once we enter a trade, we manage based on the BCI exit strategy arsenal, not on its removal from our eligible lists. If our bullish assumption on the stock changes, we can close at any time… no minimum time requirement.
3. If there is no volatility as a result of the ER, it’s okay to use the stock today. If there is, wait for the volatility to subside… it may take a day or two.
Alan
Good Morning Alan.
I am evaluating new stock purchases to sell calls on.
The list is limited because of earnings reports. I evaluated ETFs.
ICLN strike 30 has ROO 6.8%.
PBW strike 120 has ROO 7.8%.
LIT strike 68 has ROO 6.4%.
YOLO strike 22 has ROO 9.1%
.
These are all for exp 2/19.
This doesn’t make sense that the ROO is so high.
What am I missing?
Barry R
Barry,
The reason the returns are so high relates to the implied volatility of these ETFs. See the IV column in our reports (50% – 70%).
That said, we can mitigate the risk of high IV securities by using deep ITM call options. Let’s assume our initial time-value goal range for monthly expirations is 2% – 4%. We check the option-chain for ITM strikes that return 2% and then have a look at the downside protection these strikes offer… it will be huge.
This will allow us to use elite-performing, high-volatility securities in a low-risk manner.
Alan
Hi Alan.
First allow me to commend you on your website and your videos and books. You are a class act and I like the way you acknowledge your team in all you do.
I have done more training than you can shake a stick at in my career and I am very very impressed. I have been involved in the maintenance, instruction, and flying of my personal planes and corporate jets for over 40 years. You can imagine the training that occurs just to maintain all these licenses!
A small question WRT writing ITM call s on stock that I own.
Take for example FCEL. A February 19th call at 13. My premium was 4.20 a share. In my mind, that option is in danger of being called anytime the stock price rises above 17.20 a share. is this correct and also is this the downside of buying ITM calls in a volatile stock such as this? Take for instance today at 17.40.
Promise not to be a pesky member but just trying to wrap my brain around the ITM covered calls. before you I only did OTM covered calls.
Best regards,
Scott
Scott,
Thank you for your generous comments.
Early exercise is possible but extremely rare especially when there is no dividend issue. FCEL closed at $18.13 and the $13.00 call option had a bid-ask spread of $5.80 – $5.90 (see screenshot). The intrinsic-value of the premium is $5.13. Early exercise would result in an intrinsic-value benefit of $5.13 per-share but a loss of time value of $0.67 per-share.
Currently, your status of this trade is excellent.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan
Hi Alan,
I’m having a hard time understanding the rates of return and how to calculate it.
1) How do you calculate return on investment month to month when/if the stock goes down and you want to sell the stock. For example.. lets say in the first month you make a 3% on your short call and your stock growth was 2% = 5%, wow, great.. but the next month your short call expires worthless so you still get the 2% but your stock drops 10% and you want to sell your stock. You are now down 8% but what about the PREVIOUS MONTHS 5% stock growth… this was UNREALIZED.. correct?? ..
So when you sell the stock this month all those previous gains have been wiped out because they were all unrealized until you sell the stock. You would think then this would be a separate line item on a trading spreadsheet instead of calculating and tracking “additional growth” since next month that could be wiped out.
2) Furthermore, assuming that the next month the stock decreases lets say from $100 to $50 after you bought the stock at $100 and you sell the covered call for $2.00. Do you calculate your return based on what you bought the original stock at ($100) or the new price of $50.
I’m a little confused with the rates of return formulas..
Thank you!
Best,
Jon
Jon,
There are several questions within your inquiry, so let’s get started:
1. There are 2 sets of calculations we must master: initial trade structuring and final results. Comingling these will lead to confusion and is a common hurdle we must overcome. We can also complicate matters when we are calculating results over multiple time-frames, in this case 1 and 2 months.
2. If an option expires worthless, we have a realized option return and an unrealized stock return. If we total the 2 legs of the trade at the end of a contract, it is an unrealized return.
3. If a stock price moves down substantially in the second month, we use exit strategy management to mitigate losses. There was no mention of that in your question and certainly we would never allow a stock to drop from $100.00 to $50.00 (I know it was a hypothetical) without taking focused, non-emotional action to reduce losses or even turn losses into gains.
4. Finally, let’s look at the 2-month hypothetical where the stock is sold at the end of the 2nd contract at a loss and we are calculating realized 2-month results for these OTM strikes:
[(option credit/debit) + (stock credit/debit)]/Initial price of stock when trade originally entered = 2-month % return. The numerator represents our 2-month $ return.
Exit strategy implementation will play a huge role in these final outcomes.
Your due-diligence to master these calculations is a sure recipe for success.
Alan
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This week’s 4-page report of top-performing ETFs and analysis of the top-performing Select Sector SPDRs has been uploaded to your premium site. One and three-month analysis are included in the report. Weekly option and implied volatility stats are also incorporated.
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Alan and the BCI team
Hi Alan,
I seem to have a “continual monthly” problem (reoccurring for me month after month) and could surely use your advice and expertise!! HELP!!
In hindsight, I have fortunately made very good stock and ETF purchase selections for my pretty much conservative covered call writing, thanks in large part to my hours of due diligence and of course due to BCI.
I have usually selected stock/ETF strikes that are 2 or 3 strikes OTM. I achieve a good initial option return premium of usually around 2% or so. And sometimes I will ladder up my OTM options to maybe as high as 4 strikes OTM. I do little (if any) ITM selections and did none for the February, 2021 monthly contract period.
My problem has been that my stock/EFT selections have been so good that the stocks/ETFs have immediately increased and increased dramatically. I am therefore tapped out of any additional profit or appreciation on my stock/EFT and option selections, netting me maybe a total of 3% to possibly 3.5% overall return. I’m leaving money on the table.
I placed my February monthly stock/ETF purchases and STO trades on Tuesday morning starting 1 1/2 hours after the opening bell and after the MLK holiday. All of my stock/ETF selections were purchased OTM…. and were ITM by Wednesday market close (today), two days later and leaving many, many thousands of unrealized profit dollars on the table.
I noted that in your latest BCI Weekly Stock Screen report, you stated that you will be favoring OTM strikes 2 to 1 over IMT strikes for the February (monthly) contracts. This tends to make me think you are placing even more conservative stock/ETF selections than me (as I have no ITM selections) and you (Alan) may have the identical issue of immediate stock/ETF appreciation and your very quickly maxing out your February, 2021 contracts and stock/ETF profit.
Of course, you and I could BTC and/or roll out the positions or not even place covered calls in the first place (which defeats the purpose of the BCI). But… should I normally wait to do so (BTC and/or roll out the positions until the individual stocks/ETFs take a price “pull back” or just sit tight and do nothing until Friday, February 19th??
Of course, I would only do this when I think the stock market climate in general is right for additional increases and when the same is true for the individual stocks/ETFs.
Alan, thank you as always. I look forward to your response.
Tay
Hello Tay,
every week someone here is concerned about “leaving money on the table”.
We, the BCI believers, we cheer when an underlying stock goes up, the more the better.
We feel that our trade is protected, and will end up assigned, so we will realize our ROI within the 2% and 4% range.
Please tell me where you can place your cash and get 2% in one single month elsewhere?
Forget the notion of lost opportunity. You should worry about the losers and manage them to mitigate your losses. The winners are welcome to go to the sky.
Roni
Tay,
I’m struggling with the word “problem” You are reporting an annualized return range of 36% to 42%. I’m afraid I will not be sending you a case of Kleenex for Christmas this year… you’re doing great.
When we establish our covered call trades, we are generating an initial time-value return that aligns with our stated goal along with either upside potential (OTM strikes) or downside protection (ITM strikes). In return for getting paid, we are capping the upside and incurring the risk of share depreciation below the breakeven. In your trades, you are maximizing the returns… maybe a case of champagne rather than Kleenex?
I know you to be quite diligent and so we keep the mid-contract exit strategy in mind for possible additional income streams when share price accelerates significantly. A structured plan executed appropriately will allow us to beat the market on a consistent basis, significantly in many years..
Every strategy has its pros and cons. There isn’t a book I wrote of video course I produced where I didn’t detail these. Once accepted, we should celebrate the results you are achieving. I am for you…you?
Keep up the great work.
Alan
Hi Tay,
A few comments in addition to Alan’s comments, here a few things that you can do if you are truly concerned about “leaving money on the table”, although outside of the BCI methodology…
+ When selling covered calls, you could leave some portion “uncovered” to take advantage of any quick price rise. For example, buy 300 shares but sell only 2 contracts.
+ You can buy additional stock. For example, but 350 shares and sell 3 contracts.
+ You can buy upside calls. Think about calls with a Delta of .7. This long call can act as a “stock surrogate” and give you the upside should the stock move quickly. Remember, when you buy an option, you have to consider Theta or time decay. In the case of long calls, Theta is working against you…very different than selling calls when Theta is working for you.
Best,
Barry
+
Alan,
A TD Ameritrade Rep. Told me recently that if I Sold to open with an in the money strike on Oxy my chances of assignment were much greater before the expiration date? Whats up with that? Shares on OXY were declining and I wanted to roll out from 28.00 down to 19 or 20.00 and for the next week on the 29th when he said that.
James
James,
We are selling “American Style Options” which can be exercised at any time. However, early exercise is extremely rare for several reasons two of which are:
1. The option buyer will lose the time-value of the ITM option and receive only the intrinsic-value component.
2.Most option buyers want to be option-sellers, not shares owners.
When early exercise does occur, it is usually associated with a dividend which does not apply in this case at this time with OXY.
Although early exercise is technically possible, it is extremely unlikely and we should trade accordingly.
Alan
Roni,
Amen…
Best,
Barry