Covered call trades can be entered by legging-in (2 separate trades) or via the buy/write combination form (1 net trade). When available, the latter is an effective, and perhaps cheaper, way to execute our covered call trades when the bid-ask spreads of our options are narrow. This article will explain how to use the combination form using a real-life example with Corcept Therapeutics Incorporated (NASDAQ: CORT), a stock on our premium stock watch list on 9/8/2020.
Initial trade structuring
On 9/8/2020, CORT was trading at $19.98 and the 10/16/2020 $21.00 call showed a bid-ask spread of $1.35 – $2.20. Leveraging the Show or Fill Rule, we will seek a bid premium of $1.70 for a 5-week expiration. Here is the option-chain for CORT on 9/8/2020:
CORT: 5-Week Option Chain on 9/8/2020
Initial calculations with the multiple tab of the Ellman Calculator
CORT: Initial Calculations with the Ellman Calculator
Legging-in
- Place a market order to buy 100 shares of CORT
- Once executed, place a STO (sell-to-open) limit order for 1 contract at $1.70
Buy/write combination form
CORT: Buy/Write Combination Form
- Go to buy writes & unwinds (titles may vary slightly from broker-to-broker)
- The net debit limit order is set at $18.28 ($19.98 – $1.70)
- Day only: if not executed, we re-evaluate the next trading day
- Review and confirm order
- Once executed, place a buy-to-close limit order on the option side based on our 20%/10% guidelines ($0.35 or $0.15)
Discussion
Covered call trades can be executed by legging-in or with a buy/write combination form. Both are acceptable with a possible slight advantage to the latter when the bid-ask spread is small. Legging-in may be a better approach when the spread is wider so we can leverage the Show or Fill Rule.
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:
Hi Alan,
I’m a new BCI member in the second week of my second monthly expiration cycle. I’ve read your encyclopedia and your book on exit strategies (twice), and immersed myself in the Ask Alan videos. I think the work you do is very important, and it’s amazing that you give retail investors so much confidence. I’ve read other books by other money experts who look down their nose at the retail crowd and I find your common-sense approach very refreshing.
Thanks,
Phil
Upcoming events
1. AAII Research Triangle NC: Private webinar
April 10,2021 at 10 AM ET
Zoom webinar- details to follow
2. Wealth365 Summit: Free webinar
April 19th – 24th
Time and date to follow
Topic: Portfolio Overwriting: Covered Call Writing Long-Term Buy-And-Hold Portfolios
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Market tone data is now located on page 1 of our premium member stock reports and page 1 of our mid-week ETF reports.
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Alan,
I have a question regarding the PCP method discussed in the BCI program.
I have a CSP on the IWM ETF and if assigned, was thinking of buying a collar in the RUT to hedge for downside protection.
I was looking at multiple strikes and it seems as though I could finance the RUT put with the RUT call for a credit.
What am i missing? If assigned on the IWM ETF, I would initiate a Covered Call on the IWM and then hedge with an at the money RUT, Collar 30-90 days out for protection?
What are the drawbacks/risks to this approach?
Many thanks!
Robert
Robert,
Using protective puts when writing covered calls (collar trades) is a reasonable approach when we have concerns about downside protective.
The put purchase will place a floor on the downside and the call sale will create a ceiling on the upside. There should be a net credit or, at worst, a breakeven on the 2 trades.
My preference is for 1-month trades. If the intention is to hold the security for the longer-term, buying longer-term puts is okay but calls should not be in place when earnings reports are made public.
Please explain “RUT”
For more information on the collar trade:
https://thebluecollarinvestor.com/minimembership/covered-call-writing-alernative-strategies/
https://thebluecollarinvestor.com/minimembership/video-the-collar-strategy/
https://thebluecollarinvestor.com/minimembership/collar-calculator/
Alan
Alan,
Is it a good idea to use protective puts for stocks we want to hold over earnings reports?
Thanks, as always,
Marsha
Marsha,
Yes, this is a reasonable way to provide protection against a disappointing report.
The benefit: Protection against stock price dropping below the put strike.
Liability: Cost of put (insurance costs money unless we are using ITM call strikes). Since we are buying the protective put prior to an earnings report, the cost will be higher-than-normal because the implied volatility is greater due to the uncertainty of the report results.
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 03/26/21.
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:
http://www.youtube.com/user/BlueCollarInvestor
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.
The ETF report for this upcoming week will be published either late on Thursday or early Friday.
Best,
Barry and The Blue Collar Investor Team
[email protected]
Allan,
I am a new premium member and soaking up all the information you and the BCI team provides. My question is about implied volatility which is in some of your reports. How do we know which implied volatility to select or stay away from?
Thanks for all you do.
Jordan
Jordan,
IV must be factored into our option-selling decisions. It is directly responsible for the amount of premium we generate and also measures the risk we are incurring.
We don’t have to look up IV for all our trades as long as we define a specific initial time-value return goal range for near-the-money strikes and that will allow us to avoid IV that does not align with our personal risk-tolerance. In my portfolios, I use 2% – 4%. in my mother’s, I use 1% – 2% for 1-month expirations.
IV does have its limitations. Most vendors provide IV stats based on 1-year projections and 1 standard deviation, meaning its accuracy is expected 68% of the time.
Bottom line: IV must be factored in but not over-emphasized.
Alan
Alan,
I’m curious if you are still using the put strategy you wrote about several months ago where you sell weekly puts with delta of less than 10? If you are, how often are the puts exercised where you buy the stock?
Thank you.
Jorge
Jorge,
Yes, I am still using this strategy in one of my smaller portfolios where I sell between 10 -20 contracts per-week.
I developed this strategy in response to COVID-19 and its potential impact on the stock market. This is the only time I use Delta in my strike selections because of the specific nature of the market concerns. I only use underlying securities I would not mind owning in my portfolio. My target annualized initial time-value return goal range is 10% – 20% although I have gone as low as 8%.
Exercise has occurred 2 times, both with ETSY. Each time, I was able to sell the stock at a significant profit the following week.
The majority of my option-selling portfolios is active with traditional option-selling strategies as this one has proven to be reliable in extreme volatile circumstances.
Alan
Allan,
A friend recently sent me your encyclopedia for a birthday gift and I am in the early chapters so I’m sure the answer to my question is in this book. However, curiosity calls. Do you have guidelines when to roll down an option versus selling the stock in a covered call trade? Specifically when we are below breakeven?
Thanks a lot.
Ellen
Ellen,
In our BCI methodology, our position management skill set allows us to react in a non-emotional manner to all possible scenarios based on sound fundamental, technical and common-sense parameters.
In our covered call trades, all exit strategies begin with buying back the short call. This will be based on our 20%/10% guidelines.
In addition to rolling-down and selling the stock, we also have “hitting s double” available as an exit strategy where we re-sell the same option if share price recovers.
The decisions available will be based on market conditions and time-to-expiration.
I suggest mastering the material in the book before entering additional trades especially the chapter on exit strategies. It will be worth the investment of time and, in the long run, put a lot more cash in your pocket.
Welcome to our BCI community.
Alan
Hi Alan,
I WOULD LIKE TO KNOW IF YOU KEEP THE STOCK DURING THE EARNING SEASON ,EVEN IF YOU HAVE NO OPTION TRADED ON IT OR YOU JUST SELL THE STOCK
THANK YOU
RAYMOND
Raymond,
In my option-selling portfolios, I will rarely hold a stock through an earnings report. If I like stock, I will buy it after the report passes and then write the call.
Over the years, there have been a handful of stocks that historically had positive reports that I may make an exception but those are few and far between.
Alan
Hi Alan
Thank you,I will do that ’do you exit few days earlier, Raymond
Raymond,
Any time prior to the report will mitigate the risk of an unfavorable report.
Alan
Hi Alan,
I recently bought a stock for $35(100 shares).The stock is currently trading at $30.I am selling the covered call(1 contract) for this stock at $37 strike price expiring on April 16 and getting $70 dollars premium.If the stock price goes above $37 I have to assign the shares but what is the risk for me if the stock price falls to $33.Thanks.
Rajendra,
If share price remains under the $37.00 strike, exercise is extremely unlikely. No action is required to retain the shares.
If share price moves above the $37.00 strike, we can avoid exercise by buying back the call option prior to 4 PM ET on expiration Friday.
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 performance has also been incorporated into the report although not part of the screening process. Weekly option availability and implied volatility stats are also incorporated.
The mid-week market tone is located on page 1 of the report.
For your convenience, here is the link to login to the premium site:
https://www.thebluecollarinvestor.com/member/login.php
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Alan and the BCI team