Whether we are writing covered calls, selling cash-secured puts or simply buying and selling stocks, the first important requirement is to develop or have access to a quality watch list of elite-performing securities. Once we have purchased a stock or exchange-traded fund (ETF), our goal is to make a profit. In this article, three approaches to generating cash will be explored using a stock from the BCI Premium Watch List as of June 2, 2016.
Real life price chart of EDU as of 6/2/2016
Note that since the short-term moving average (blue line) moved above the longer-term moving average (red line) at the brown marker, the price has doubled in about seven months. At this point there are three ways we can benefit from owning such a security:
In this case we remain share owners and do not use options. However, we do want to protect against significant share loss to the downside so we instruct our broker to sell the stock if it drops a certain percentage below its highest point, say 10% This is the figure I recommend in my book, Stock Investing for Students. With EDU trading at $42.70, the initial stop loss order would be at $38.51 or lower. Now if EDU moved up to $45.00, the stop loss order would move up to $40.50 ($45.00 – 10%). As share price moves higher, so does the stop loss order so upside is never capped but the downside is limited.
2- Write a covered call
This is my favorite strategy so let’s have a look at the options chain as of 6/2/2016 for the 7/15/2016 expirations:
The yellow highlighted area shows an initial return of $1.20 for the $44.00 call strike. Let’s check with the Ellman Calculator:
We see an initial 6-week return of 2.8% (ROO) and the possibility of another 2.8% (upside potential) if share price moves up to the $44.00 strike by expiration. There is a potential 5.6%, 6-week return…not bad. This return can even be improved if we “negotiate” a better bid price by leveraging the “Show or Fill Rule” perhaps generating $125.00 or $130.00 instead of $120.00 from the initial option sale.
A conservative way of managing covered call positions is to purchase a protective put to defend against substantial downside share loss. When the premium generated from the call sale negates the premium spent on the put purchase, the process is referred to as a zero-dollar collar. As an example taken from the option chain shown above, if we generate $1.20 from the sale of the $44.00 call and buy the $41.00 put for $1.20, the collar does not cost any money (perhaps commissions).
- Protected against share loss below $41.00
- Protection is free
- Opportunity for share price to move up to the $44.00 call strike or 2.8%
- Maximum gain is now 2.8%, not 5.6%
- Protection is good but not perfect as we can still lose $1.79 per share
Other collar combination strikes can be employed based on return goals and amount of protection desired.
Whether we are simply buying and selling stock, writing covered calls or using the collar strategy, a high-quality watch list of securities is essential. From there. we must decide which approach for income generation will most closely be compatible with our trading style.
Upcoming live events
November 5, 2016
Plainview, New York
Saturday morning 3-hour workshop at the Plainview Holiday Inn. I am the only speaker and plan an information-packed presentation covering 5 actionable ways to make money or buy a stock at a discount using both call and put options. We will also evaluate the stocks you currently own for option-selling. Bring a list of stocks currently in your portfolio.
December 6, 2016
Options Industry Council Webinar Summit
Tuesday afternoon…1:30 Pm ET:
Those who register but cannot make the live event will be sent a link to the presentation recording.
February 27, 2017
Stock Trader’s Expo
Marriott Marquis Hotel, NYC
1:30 PM ET
Exhibit hall Booth 208 (February 26th – 28th)…come say hi to the BCI team
Global stocks were modestly lower this week, as interest rates stabilized. Expectations are for a December rate hike from the US Federal Reserve. Volatility, as measured by the Chicago Board Options Exchange Volatility Index (VIX), rose to 16.19 from 14 a week ago. Oil prices declined this week. West Texas Intermediate crude fell to $49.25 from $51 last Friday. This week’s reports and international news of importance:
- Firmer economic data, particularly in Europe and the United Kingdom, helped extend the recent move higher in most global bond yields
- The Citigroup Economic Surprise Index, which measures how economic data fares relative to expectations, has shown a positive trend, as both the eurozone and the UK have held up well in the wake of the surprise Brexit vote in June
- German 10-year bunds are solidly in positive territory
- UK 10-year gilts are at post-Brexit highs of 1.26% after strong Q3 GDP data
- The US 10-year yields are trading near 1.85%, the highest level in four months
- The US had its best quarter of economic growth in two years in the third quarter, according to data released by the Bureau of Economic Analysis. The economy expanded at a 2.9% annual rate, boosted by a rise in inventories and on a narrower trade deficit
- Consumption, which had kept the economy afloat in prior quarters, was soft in the 3rd quarter
- The eurozone manufacturing PMI rose to its own 30-month high at 53.3
- Despite the upbeat data, inflation remains below the European Central Bank’s 2% target. The ECB is expected to extend its quantitative easing program for six months at its December meeting
- Data released Friday showed that the French economy expanded 0.2% versus the prior quarter, while Spain grew 0.7%
THE WEEK AHEAD
- Daylight-saving time ends in the UK and Europe on Sunday, October 30th
- Eurozone GDP and CPI numbers are released on Monday, October 31st
- The core PCE price index—the US Fed’s favorite inflation measure—is released on Monday, October 31st
- The Bank of Japan meets to set interest rates on Tuesday, November 1st
- Manufacturing PMIs are released globally on Tuesday, November 1st and Wednesday, November 2nd
- The Fed’s rate setting committee meets on Wednesday, November 2nd
- The Bank of England meets to set interest rates on Thursday, November 3rd
- The US employment report is released on Friday, November 4th
For the week, the S&P 500 declined by 0.69% for a year-to-date return of +4.03%.
IBD: Uptrend under pressure
GMI: 4/6- Sell signal since market close of October 12, 2016
BCI: I am currently favoring in-the-money strikes 2-to-1. It appears that institutional investors are expecting a Clinton victory which would then result (if my assessment is correct) in a stable market response. Those who expect a Trump victory may want to take a more defensive posture than I have.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
The charts point to a neutral to slightly bearish outlook. In the past six months the S&P 500 moved up by 3% while the VIX rose by 5%.
Wishing you the best in investing,
Alan ([email protected])