After entering our covered call writing trades, we immediately enter our 20% buy-to-close (BTC) limit orders. This will automate the process to close our short calls in the first half of a monthly contract should share price decline significantly. This article will highlight such an opportunity that occurred with Procter & Gamble Company (NYSE: PG) in May 2020 for the June contracts
PG trades
- 5/18/2020: 100 PG purchased at $116.21
- 5/18/2020: 1 x 6/19/2020 $117.00 call sold at $1.40
- 5/26/2020: 1 x 6/19/2020 $117.00 call closed at $0.30 (meeting the 20% threshold)
- 5/28/2020″ 1 x 6/19/2020 $117.00 call was re-sold at $1.90
PG price chart with the classic V-shaped “hitting a double” pattern
PG Price Chart in May 2020
PG option chart with the classic V-shaped “hitting a double” pattern
PG Option Chart for the $117.00 Call
“Hitting a Double” calculations with the multiple tab of the Ellman Calculator
PG Exit Strategy Calculations
The initial trade structuring was for an initial time-value return of 1.2% with an additional 0.7% as upside potential for a total 1-month maximum return of 1.9%. With the BTC limit order executed, the initial return was reduced to 0.9%. When the $117.00 call was re-sold, the time-value return was elevated to 2.6%, more than double the original return.
Discussion
Exit strategies are difference-makers. In this real-life example with PG, the time-value return was doubled and the trade was still early in the June contract where other opportunities may arise.
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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:
Alan,
Your site has been the inspiration for me to start doing covered call writing and puts in my accounts. This year, I will have gains, as of 11/25/2020, of $340,000 because of you and your video tutorials.
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Hi Alan,
I’d be grateful for your insight into something I’ve been thinking about.
Given a lot of (most?) stocks have only monthly options instead of weeklys, we’re in position whereby we enter positions just once a month, which won’t necessarily be the best time to enter the market.
Is it better, then, to trade, for example, the S&P 500 index which does have weekly options, and enter a trade at optimal times, instead of waiting for one opportunity a month to trade monthlies where we have to take whatever market conditions exist at that time?
That also begs the question, with your strategy, is the main concept swing trading stocks or selling the calls to get the premium? If we’re not always getting optional entries, it would seem it is the latter. If it is swing trading, entering at optimal times, then we’re pretty much bullish on every trade, which kind of makes selling calls redundant, does it not, because we stand to gain more from share appreciation than the premium received?
I’d be grateful for any insight on the above.
Best,
Andrew
Andrew,
I would not limit the pool of securities to those that have Weeklys. That said, you will have several securities in our stock and ETF reports that do have Weeklys and almost all of the stocks in our monthly Blue Chip (Dow 30) Reports have Weeklys.
In my view, if a stock and its industry is in favor at the time of trade execution, it is reasonable to enter that trade even if market conditions aren’t prefect. We can accommodate by taking defensive positions like ITM calls and deeper OTM puts among other techniques.
Swing trading vs. generating cash-flow: Both. Our goal is to develop a low-risk strategy to create passive income (profits) in a weekly-to-monthly time-frame. If I had to pick one… making money.
Alan
Andrew,
I wonder what you consider “optimal times” or the “best time to enter the market”?
I do really have problems with this.
Usually, I will be entering my monthlies in the first week after the expiry weekend, and I always have problems deciding if I should enter on a down day or an up day.
Roni
Roni,
I find that accurately timing the market is impossible and I don’t want to lose time value premium so I enter my trades on the Monday after expiration. Waiting longer may or may not work out.
Good luck.
Marsha
Marsha,
thank you so much, I will try to do the same as you, and capture the best premium on Mondays after expiry.
Actually, after I wrote my post, I gave the subject some serious thought and concluded that for the BCI methodology and my personal focus on monthly CC selling, the market down days presents a slight advantage.
The risk of placing our trades is lower when the market is down because the underlying stock represents more than the premium in the equation.
Good luck to you too – Roni
Hello Alan,
I’m paper trading practicing your teachings. I have attached a spreadsheet detailing the rolling down exit strategy for one of my December positions and was wondering if you may provide feedback on it when you have a moment.
The first tab compares rolling down vs not and assumes the stock will close above the rolled down strike price of $105.
The other tab assumes the stock price continues to fall but I will closeout the position at a 7% drop in stock price (Convert Dead Money to Cash)
Today is week 3 of the expiration period and I believe I need to roll down now as the premium will continue to decrease as we move into week 4 and closer to expiration.
Also, do any of the BCI calculators have a tab that allows review/setup of the rolling down technique? I think it would be associated with the “Unwind Now” tab but it didn’t appear to me that this tab allows for analyzing rolling down.
Last month was my first paper trading month using the BCI methodology and I used the “Hitting a Double” exit strategy that greatly reduced my losses and squeaked out a 0.62% gain vs a 1.09% loss.
This month I’m currently doing a lot better and am absorbing the “Rolling Down” exit strategy. I just purchased the BCI Trade Planner and will be going back to set it up for my December positions to see how it works.
Another item I have struggled to understand has to do with the “Convert Dead Money to Cash” (CDMTC) exit strategy. At what point do you implement it? One would reach the 20%/10% BTC level of the position first looking to hit a double. What loss level would you recommend using before implementing CDMTC? I see the Trade Planner uses a 7% stock price decline for this but it was not clear to me in any of your books. Great books by the way!
I know you must be very busy and this is a long email. Any further insight you could provide would be greatly appreciated.
Thank You,
Alan K
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan,
Currently, the only BCI calculator with a rolling-down tab in the same contract month is the PMCC Calculator. This may be a valuable addition to our products… let me give it some thought.
I can offer an alternative approach using the “multiple tab” of the Ellman, Elite, and Elite-Plus Calculators (see screenshot below). Let’s focus on the $115.00 call (see attachment):
Top row: This is the initial trade structuring.
Second row: Status of trade after closing the initial short call at $0.45.
Third row: Status after rolling-down to the $105.00 strike.
The net position at that point in time is -1%.
To check: Stock loss = $5.68
Option credit = $4.60
Net loss = $1.08
$1.08/$110.55 = 0.98%
CDMCP: The 7% guideline is reasonable. I also look at performance in comparison to the S&P 500. I March, everything was down big time. I closed and moved to inverse ETFs. The key is to take advantage of any and all exit strategy opportunities whether they are to mitigate losses or enhance gains.
I’ll keep our members posted if there are any additional enhancements to our calculators.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
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 12/11/20.
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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Barry and The Blue Collar Investor Team
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Hi Alan,
I’ve been wondering about the rules around Trade Profit Calculation (TPC).
Question: Is the TPC to be complied with only on the first trade? Or must it be complied with for each subsequent trade, where the short call expires worthless and a new call is sold on the same long stock?
I understand that we should not put on a covered call trade where, if assigned, we would lose money. However, if we’re in the trade for a couple of weeks or months and one or two short calls expire worthless and we get to keep all the premium, I wonder what you would think of accepting subsequent trades that don’t comply with the TPC.
Sometimes the stock moves down so much that I can no longer sell short calls against it for any appreciable premium. But if I chose lower strikes, closer to ATM, I could take in reasonable premiums, but that contradicts the TPC. What if I only did that to the point of break even after calculating in previous short call credits?
Or what if I regularly avoid assignment by rolling? If I takes steps to avoid assignment, is
I’ll appreciate your feedback. Thx.
Dave
Dave,
There are 2 sets of calculations that must be understood and not comingled:
1. Initial returns (ROO, in the BCI methodology): The time-value of the premium divided by the current value of the stock at the time of trade entry (not a previous price). If we sold an in-the-money call option, the intrinsic-value of the premium is used to lower our cost-basis to the ITM strike. The BCI calculators will do the math for us.
2. Final returns: If an option expires out-of-the-money, we have realized the initial ROO and have an unrealized gain or loss on the stock side (not yet determined) depending on the price of the stock in relationship to the purchase price. For example, if we bought a stock for $48.00 and sold the $50.00 call for $1.50 and at expiration the share price is $49.00, we have a realized capital gain on the option side of 3.1% ($1.50/$48.00) and an unrealized stock gain of $1.00 on the stock side. If we retain the shares the following contract week or month, our cost-basis for that initial trade is $49.00. If share price declined, that current price would represent our cost-basis for initial trade calculations.
If share price moves to $51.00 and we take no action to roll the option, our shares are sold at $50.00. Now, we have a realized capital gain on the stock side of $2.00 or an additional 4.2% ($2.00/$48.00).
If share price moves down significantly, we must execute the appropriate exit strategy opportunities to mitigate losses and ultimately decide if we want to retain this security in our portfolio.
To sum up: Initial trade calculations are based on current, not historical, data. Final calculations are determined when the option leg or stock leg is closed.
Alan
Thank you, Alan. I appreciate your quick reply and thoughtful explanation. You’re a great mentor!
Alan,
I have a stock that has a ER due next month so I’m avoiding selling calls/puts but I was wondering if you sell all your equity positions as well in the stock if the ER is due…or you just don’t trade the options?
I have a stock where the analysis looked strong but one analyst (JPM) gave it a downgrade. When that happens do you immediately stop using that equity?
When a analyst company provides a future price target do you give that much thought when selecting your strike prices?
Thank you!
Courtney
Courtney,
My responses:
1. Generally, if there is an upcoming ER in the current contract month or week, I will not include that security in my portfolio. There are some exceptions when I have a lot of confidence in a company that has a history of favorable ERs. or simply stocks I consider long-term portfolio holdings. In these latter scenarios, I do not sell the option until the report passes. Weeklys can be helpful in these situations, when available.
2. A single analyst downgrade plays no role in my overall analysis.
3. Strike selection is based on initial time-value return goal range, moneyness determination ( in-the-money, at-the-money, out-of-the-money) and personal risk-tolerance. Future price target analysis plays no role in these decisions… our trade decisions and obligations are short-term.
Alan
Courtney,
Another approach you can take if you really want to keep the stock during the month that the company reports earnings is to use a “Collar”. A collar is a covered call trade that is combined with buying a protective put. This scenario assumes that you own the stock and want to keep it during the earnings report period. Essentially, the OTM call that you sell will cover the cost of buying the OTM put…sort of buying an insurance policy.
This way, if the stock has a “good” earnings report, you could then sell the put a day or two after the report and recover some of the cost of buying the put. If they have a “bad” report, you will have a known loss that is limited by the strike price of the put that you select…especially if there is a big drop in price due to that negative earnings report.
The collar is one of my favorite trades. I use it frequently, especially if I can,t be near my trading computer for awhile. This is also my go-to trade when I go on vacation.
We have a number of blog articles on the collar trade as well as our more in-depth book called “Covered Call Writing Alternative Strategies” (CCWAS). CCWAS is available on our website.
Best,
Barry
Thank you for the advice! I’m one month into the BCI strategy and really enjoying it.
Best Regards,
Courtney
Hi Alan
If I may indulge you about a problem I’m having. What would you do in this scenario:
Buy XYZ at $200, 100 shares, sell CC at 205, weeklies. By Friday the stock is at 190, 5% down, option is about to expire,
I buy it out at 1 cent, so I can get a new weekly CC on Friday instead of the following Monday, 2 extra days of time value, but now the $205 and $200 calls are meager, and if I buy the $195 call, I could lose the stock if the price moves back up over 195.
I’m not at the 7% loss yet on the stock, What would you do in this situation? Seems to happen to me often.
Best,
Victor
Victor,
A stock that has declined $10.00 in 5-days was probably eligible for rolling-down based on the 10% guidelines. That’s the first exit strategy to be considered.
Now, if the strike is out-of-the-money significantly on expiration Friday, the short call does not need to be closed. The market-makers have already discounted the 2 weekend days of time-value for our premiums on Thursday or Friday. 7 days of time-value is discounted over the 5 weekdays.
As the option expires worthless, we decide if the stock will remain in our portfolio for the next week and set up our next option-selling portfolio from there.
Alan.
Hi Alan,
I understand how hitting a double or possibly more on the same stock in one month can happen. What do you do if your calls jump almost immediately to the strike price? During the first week 6 of my 7 monthly calls were at or over the strike price. Do I just sit out the rest of the month?
Mike
Mike,
This is the ideal scenario for the mid-contract unwind exit strategy when the time-value cost-to-close approaches zero. Here is a link to an article I previously published on this topic:
https://www.thebluecollarinvestor.com/closing-our-entire-covered-call-position-when-share-price-rises-the-mid-contract-unwind-exit-strategy/
For more detailed Information:
“The Complete Encyclopedia for Covered Call Writing-classic edition”: Pages 266 – 273
“The Complete Encyclopedia for Covered Call Writing- Volume 2”: Pages 244 – 252
Use the “Unwind Now” tab of the Elite and Elite-Plus Calculators to determine the time-value cost-to-close.
Alan
Alan:
Do you stay away from etf ex-dividend dates? Aren’t they very predictable? There shouldn’t be any earnings surprises. Which means that the etf price will drop by the expected dividend on the ex-dividend date?
Jerry
Jerry,
ETFs have no earnings reports so ex-dividend dates is our main concern if retaining the shares is critical to our strategy. Not all ETFs generate dividends but for those that do, circumventing the ex-date to ensure share retention may be considered.
Early exercise is extremely rare, even regarding ex-dates. For me, I have no problem with early exercise because it means that I’ve maximized my initial trade and now have the cash back to re-invest for a second income stream. Avoiding exercise may be important when there are potential tax consequences.
You are 100% correct that share price will decline by the dividend amount on the ex-date, all other factors being the same.
Alan
Premium members:
The Blue Chip (Dow 30) Report for the January 2021 contracts has been uploaded to your member site. There are 10 eligible securities in this month’s report. Look on the right side of the member site in the “resources/downloads” section.
Alan
Premium members:
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.
The mid-week market tone is located on page 1 of the report.
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Alan and the BCI team
Dear Allen;
First I would like to wish you a Merry Christmas and also thank you for your investing advice.
Since March I have taken approx. $2700 and now is worth approx. $5400. All mostly by selling cash secured puts using your guidelines. Yes I have had a few losing trades.
I have 2 questions for you that maybe you could steer me in the right direction to answer.. First question; Is there ever a time or circumstance where you could be profitable in just Buying a call or put? Not a spread just an outright purchase of one or the other. IE; If I bought a put on an underlying When would I need to purchase the underlying stock if I have the right to sell it?
The other question is. What are the conditions or criteria in which a person may consider ITM puts or calls?
No Hurry as I know you are busy! but thanks in advance.
Sincerely
Kevin
Kevin,
Buying calls or puts can be lucrative if directionally correct and the breakeven point is overcome. Let’s say we bought a stock for $48.00 and sold the $50.00 call for $1.50. Our BE is $46.50.
Now, if we simply bought the $50.00 call for $1.50, our BE is $51.50. This is why I favor the sell-side of options. For those looking for greater potential returns, buying calls and puts may be appropriate.
If we buy a put, we never have to buy the stock. If we are directionally correct and the stock price decreases in value causing the put value to surpass the BE, we can sell the put for a profit.
Use ITM calls when looking to achieve a defensive covered call position and ITM cash-secured puts when looking to buy a stock at a discount and purchasing those shares as soon as possible.
Alan
Link to my Stockcharts.com interview this evening:
https://www.youtube.com/watch?v=AVcMyWx2BAU&feature=youtu.be
I go on at about 12 minutes