Covered call writers or cash-secured put sellers who use ETFs (as opposed to individual stocks) tend to be novice put writers, more conservative investors, or have limited funds or time. If you fall into any of these categories, knowing your risk level is critical to your investment decisions and specifically, to which underlying securities you select. One way to evaluate this risk level is to view the current implied volatility (IV) of the associated options. IV is the forecast of the underlying security’s volatility as implied by the option’s price. The implied volatility is calculated by taking the market price of the option, entering it into an option-pricing model and back solving for the value of the volatility. The higher the implied volatility, the greater the option premium will be but also the more risk incurred regarding potential downward movement of share price. The figure below is an example of the implied volatility stats we provide to our members in our premium reports (which can also be gleaned for free online as well at www.ivolatility.com) and their comparison to the overall market (S&P 500):
Another way to view implied volatility is the anticipated market view of the percentage change in the price of the security on an annualized basis in either direction. In the chart above, we see that EPI has an IV of 33.11 or about 33%. If the price of EPI was $21, then the market is anticipating a price range of $14 to $28 over the next one year ($7 in either direction or 33% of $21). The higher the IV, the more risk we are incurring for a potential price decline. As a comparison, at the top of the chart, we see the IV of the overall market (S&P 500) at the time was 13.31.
ETFs and stocks can be used as the underlying securities for covered call writers and cash-secured put sellers. The major drawback to selling options backed by ETFs is that the return or premium generated from the sale of ETF-backed options tend to be lower than the returns produced from the sale of stock-based put options (given that ETFs typically have lower implied volatility than individual stocks). In the context of writing options, ETFs tend to be more appropriate for the conservative investor, the investor with limited time or capital, or the novice investor. Personally, I prefer to write options that are associated with stock in my portfolio, however ETF-backed options are the preference when I invest for my mother’s (more conservative) portfolio. It is up to you, the reader, to determine which is best for your portfolio based on finances and risk tolerance.
Next live seminar:
Monday May 18th…click for details.
7 Pm – 9 PM
I will be focusing on covered call writing but will also provide a segment on selling cash-secured puts.
New Put-Selling DVD program coming soon
My recent seminar in NY was professionally filmed and will be part of our new DVD Program based on my latest book, Alan Ellman’s Selling Cash-Secured Puts. Look for discount promo codes for early bird ordering within the next couple of months.
With one-third of S&P 500 companies reporting first-quarter earnings so far, 71% have exceeded lowered expectations. However, profits were weakened by the strong US dollar, which gained 23% during the year ended 31 March. Only 44% of companies have topped revenue forecasts. This week’s reports:
- Orders for non-military capital goods excluding aircraft, a proxy for business equipment spending plans, fell 0.5% in March, the seventh straight month of declines
- Overall durable goods orders rose 4.0%, driven by a 31% rise in bookings for non-military aircraft and a 5.4% increase in automobile orders.
- Existing home sales rose 6.1% in March to a seasonally adjusted annual rate of 5.19 million, the highest level in 18 months
- New single-family home sales had their largest drop in the same time period, declining 11.4% to an annual rate of 481,000 units. However, sales of newly built homes rose 19.4% year-over-year
- Initial claims for US unemployment benefits rose 1,000 to 295,000 for the week ended 18 April
- Continuing claims rose 50,000 to 2.33 million for the week ended 11 April
For the week, the S&P 500 rose by 1.1%% for a year to date return of 3.2%, including dividends.
IBD: Confirmed uptrend
GMI: 6/6- Buy signal since market close of January 23, 2015
BCI: I am upgrading my defensive posture due to better-than-expected earnings reports and using an equal number of in-the-money and out-of-the money strikes. This may be adjusted as we close out this earnings season.
Wishing you the best in investing,