As contract expiration nears, we must be prepared how to manage our in-the-money (ITM) cash-secured puts. Assuming we initially sold an out-of-the-money (OTM) put which is now ITM, share price has declined. We can assume that by following the BCI guidelines for position management, the current stock price is not more than 3% below the strike price. This means that the current status of the trade may represent a small loss to a small gain.
Management choices with the ITM strike
- Buy back the short put and move on to another put trade the following Monday
- Roll the put option to the following contract month
- Allow exercise of the put and sell covered calls on the newly-acquired shares the following week (the call leg of the PCP strategy)
Buy back the short put and move on to another put trade the following Monday
- We use the management approach if the underlying security no longer meets system criteria, if there is an earnings report due out the following month or if the calculations do not meet our stated goals
Roll the put option to the following contract month
- We favor this approach if the stock still meets system criteria but overall market conditions lean bearish and selling OTM covered call will not benefit us
Allow exercise of the put and sell covered calls on the newly-acquired shares the following week (the call leg of the PCP strategy)
- In favorable market conditions we can choose to allow exercise and have the shares “put” to us and then write an OTM covered call. This will allow us the potential for 2 income streams, one from the options premium and the other from share appreciation from current market value up to the OTM call strike
Real-life rolling calculations with Intel Corp. (NASDAQ: INTC)
Buy-to-close the original $44.50 put
INTC: Option Chain to Close current short Put
Sell-to-open the next month $44.50 put
INTC: Sell-To-Open the Next Month $44.50 Strike Option Chain
Initial rolling calculations
Let’s assume we sold the original $44.50 put for $1.00 making our cost-basis $44.50 – $1.00 or $4350.00 per contract. Our net option credit is ($180.00 – $97.00) per-contract. Our initial 1-month rolling return is ($1.80 – $0.97)/$4350.00 = 1.91%. If this falls into our stated initial time-value return target range, rolling the put should be given consideration.
Discussion
Management of ITM puts when utilizing the PCP strategy includes closing the short put and using the cash to secure a put on a different stock or ETF, rolling the put to the next contract month or allowing exercise and selling a covered call. These decisions are based on overall market assessment, calculation returns and trade adherence to system criteria.
For more information on the PCP strategy and put-selling trade management click here and here.
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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:
To BCI,
I met Alan at The Money Show and I bought all his books. I had no idea what to expect for a seasoned trader and book author and I was pleasantly surprised when I read the first 3 and working on the other 2. They are the best I ever read. They are so easy to read and Alan is an awesome writer. I thought I knew it all and learned that I had a lot to learn. I learned quickly that Alan is a genius and knows more than anyone I ever met. Thanks for writing the books.
Alan A.
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Barry B
November 15, 2019 2:35 pm
Reply
#
Premium Members,
The Weekly Report may be delayed until Sunday morning due to systems work being done by Schwab. The message that I received from Schwab this afternoon is as follows:
“To ensure we’re delivering the best experience possible, we’ll be conducting routine systems maintenance on Friday, November 15 at 10:00 PM ET through 3:00 AM ET Sunday, November 17. During this time some functionality may be intermittently slow or unavailable. We apologize for any inconvenience.”
Best,
Barry and The Blue Collar Investor Team
Premium Members,
As it turned out, the areas that Schwab was working on didn’t impact the data that I needed for the Weekly Report. Net/net, the report will be uploaded as usual.
Best,
Barry
Sorry for the unrelated question but I’ve been stuck on this for days. I can’t seem to come to a conclusion on how to properly calculate returns, can someone help me using the example from the article Interpreting Exit Strategy Calculations..?
1. Buy shares at $74.00
2. Sell-to-open (STO) $74.00 call (at-the-money- ATM) at $2.50
3. Buyback $74.00 calls at $0.50 (meeting the 20% guideline)
4. Rolldown to $70.00 strike at $2.00
5. Price accelerates to $78.00
6. Buyback $70.00calls at $8.20
What confuses me is it seems there are 2 ways to do this.
Method 1:
Stock was bought for 7400 and will be sold for 7800, so +400 on stock side
Options transactions: 250-50+200-820= -420 loss on the option side
So a total loss of 20 on a 7400 position
Method 2:
You didn’t actually pay 7400 for the stock, you paid stock price minus option price, so 7150
You buy back the option for 50, so now you have 7200 in the position
You receive 200 then pay 820, so now your position cost is 820-200+7200= 7820
(even more confusing, should it be viewed that your position now cost 7200+820, and the 200 is set aside as a profit from your position?)
sell stock for 7800, so a 20 dollar loss on a position which cost 7820, that’s actually a pretty big difference from method 1.
It seems that method 2 makes a little more sense, since it better summarizes money which is actually tied up in the position. So should option debit be viewed as increasing the cost of your position, while option credits be viewed as reducing the cost of your position? Or should option credits be “set aside” as profits from your position? I hope this makes sense and someone can help me understand better, or even just the lay out of how you would calculate this, thanks so much.
Steve,
You are correct that calculations can be complicated because they can be viewed from multiple perspectives. But they can also be simplified when viewing from a practical perspective, aside from tax-related calculations. For example, when an option is closed (buy-to-close) there is a short-term capital gain or loss realized from a tax perspective but our trade continues on as we still own the stock and continue to sell options as we did with the $74.00 and $70.00 strikes in this example. Whenever possible, option-sellers should trade in sheltered accounts where tax calculations are irrelevant.
Now, in the article you referenced (https://www.thebluecollarinvestor.com/interpreting-exit-strategy-calculations-versus-final-calculations/), we are showing the final exit strategy implementation is the “mid-contract unwind” exit strategy. The time-value cost-to-close is $20.00 as you stated in your inquiry which represents a loss of 0.29%, a fraction of 1%. The cash generated form closing the position is then used to mitigate this small loss and perhaps turn it into a gain by contract conclusion.
Let’s look at the calculations through a practical (non-tax) lens:
We initially invested $7400.00. We generated a stock credit of $400.00 and an option loss of $420.00 for a net loss of $20.00 through our series of trade entry and exit strategies. This ends this series of trades with underlying #1 with a loss of 0.29% as we enter a new trade with a different underlying where our cost-basis of $7800.00. This also highlights why we need to reserve some cash in our account for exit strategy execution, at least 2% of our portfolio value.
One more thing: Prior to buying back the $70.00 call at $8.20, we could have taken no action with a 0% gain or loss: On a cost-basis of $7400.00, we had a net option credit of $400.00 and a stock position loss of $400.00. Implementing the MCU strategy allows us the opportunity to still generate cash flow by contract conclusion.
I understand that others may interpret cost -basis from other perspectives but I prefer this method which, in my humble opinion, is more practical. Although we did add extra cash into our position prior to implementing the MCU strategy, nearly all that cash is immediately recovered when we sell the stock.
Alan
Thanks Alan, it’s really cool you not only put out great investing books but are also giving coaching on using them, much appreciated.
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 11/15/19.
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
Since we are in Earnings Season, be sure to read Alan’s article, “Constructing Your Covered Call Portfolio During Earnings Season”. You can access it at:
https://www.thebluecollarinvestor.com/constructing-your-covered-call-portfolio-during-earnings-season/
Best,
Barry and The Blue Collar Investor Team
barry@thebluecollarinvestor.com
I’m certain this is a dumb question, but looking at some old videos Alan shows a “collar calculator,” is it still useful and is it buried in one of the other 2 calculators? I can’t find it.
Cheers,
John in Williamsburg, VA
John,
In the BCI community, all questions are important, never “dumb”
Here is a link to learn more about our BCI Collar Calculator:
https://thebluecollarinvestor.com/minimembership/collar-calculator/
Alan
Alan quick question.
I use E*TRADE and they show different stochastic for different charting periods. I think this is wrong as I thought the stochastic was a constant (I e shouldn’t matter if looking at one month chart or one week chart or one year chart). Is that correct or does it change based on time frame?
I contacted them and the guy didn’t know and said they’d look into it.
Thx.
Doug
The stochastic normally used is a 14 “period” look-back. So on a daily chart, the look-back is 14 days. On a weekly chart, it is 14 weeks. So it will look different for those two and any other periods.
Anyone working at a brokerage should know this.
Doug,
Great response from Tom.
The default setting for the Stochastic Oscillator is 14 periods, which can be days, weeks, months or an intraday time frame.
There are also different types of stochastic oscillators. For more information on this, check out this article I published 7 years ago:
https://www.thebluecollarinvestor.com/the-stochastic-oscillator-a-momentum-technical-indicator/
Alan
Alan,
A basic question to clarify, you mention that one may buy an in the money call, or a call may become in the money at any time prior to expiration, Q can this call be called away prior to expiration as some stocks could move 2/5 dollars a day?
Thanks,
John (from the UK)
Hi John,
Not answering for Alan but American style options, doesn’t have anything to do with geography, can be exercised, called or put, at any time. European style options, doesn’t have anything to do with geography, can only be exercised, called or put, at expiration.
In both in the USA and Europe we have both American and European style options. European style options, to my knowledge are only used with indices. For example, SPX, NDX, VIX, etc.
While American style options can be exercised at any time they rarely are. Usually it involves the ex-dividend date.
More importantly, your post carries the implication that being ITM or going ITM automatically increases the probability of exercise. Technically this may be true. In actuality most individual investors sell their ITM options prior to expiration. Most call buyers, and I sometimes am, don’t want to own the stocks and sell ITM calls and use risk management exit strategies.
Buying calls or puts is not a conservative approach to trading and is not, in my opinion, investing. IMO only overwriting a core portfolio is investing. Selling covered calls and cash secured puts is the absolute most conservative form of trading. The BCI methodology is the most efficient, simplest and less time consuming of any I have studied.
Good luck and thanks for participating in the blog.
Hoyt
Hey John
My experience is only sold calls can be exercised early because you gave up your “control” in exchange for a premium. Yet they rarely get called away for all the reasons Hoyt mentions in his great note and Alan has written in great blogs on the topic.
An interesting nuance some options buyers miss until it happens is that even if you buy one and it expires ITM you can be, and likely will be, exercised by your broker. They just can’t do it early.
A case in point from Friday is that on a gamble I had bought 2 CSCO 45 calls before their earnings that did not work. But I forgot about them and let them fall through the cracks in my trading account. Well, they expired Friday a dime or so above $45 ITM.
Sure enough, come Saturday morning I had 200 shares of CSCO n my account! I am certain my broker, who is also a market maker, found 200 shares of CSCO in their inventory at a lower cost and sold them to me! Good for them, I need to pay better attention but this will be fine…. – Jay
John,
Let me add this to Hoyt and Jay’s terrific responses:
Only the option buyer can decide to exercise early. If your intention was to ask about sold options, here is a link to an article I published on this topic:
https://www.thebluecollarinvestor.com/reasons-for-early-exercise/
Alan
Alan,
Just wondering, not questioning…. I am really enjoying BCI, your books, videos, the Weekly Stock Screener, etc!!
You use a “1 year charting” for your stock/ETF pricing, 20 and 100 day exponential moving averages, fundaments, technicals, slow stochastics, MACD, volume, etc., when your “sweet spot” is “30 day calls”?
I did not see or hear in any of your materials as to “why” you selected to us a 1 year charting/graphing.
Again, I am not questioning, just wondering. I usually use a 3 month charting via Charles Schwab Street Smart Edge. What am I missing?
Maybe because: One year is a more complete picture, smooth’s out variations, shows “special events” with “price spikes”, etc??
Thank you!!
Tay
Tay,
Each of our go-to technical indicators have specific time frames. As an example, we use (12,26,9) for the MACD histogram. Now the range we use is 1-year although our trades are for 1-month (1-week for some members). The reason I like to have a 1-year perspective is that we can get a longer-term perspective of the price movement of the underlying. For example, how has it responded after earnings reports? How long has the uptrend been active?
We use stockcharts.com and, when necessary, confirm with other charting services (freestockcharts.com, brokerage charting tools etc.). For those inclined, the chart range can be adjusted as shown in the screenshot below.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan
Alan,
Very helpful! Makes sense!
Thank you Alan.
Tay
On your report of 11/16/2019, KL has a beta of -0.49. Pls explain??
Regards,
Bert
Bert
The negative beta means that it typically behaves in the opposite direction of the S&P 500. for example, when stocks are falling, people tend to go to the “safe havens” like gold. In this case, KL is a gold mining stock. So if the market gets ugly, people might move to a stock like KL.
Barry
Hi Alan,
the 11/15 options cycle was very positive, and I am happy that 9 out of my 10 positions were assigned, plus my 49.00 SNBR calls went worthless a few cents under my strike, and I have already sold the 50.00 December 20 calls at a very atractive premium yesterday.
I can see that you are fellimg bullish for the 12/2019 cycle, and my questions, if I may ask, are:
Are you getting fully invested? Will you start this week or next week?
Roni
Roni,
So glad to learn of your recent success. You made my day!
I am bullish and fully invested and have already established my positions for the December contracts selling 2 OTM strikes for every 1 ITM strike.
Successful trading to one and all.
Alan
Thanks Alan,
I was not sure about this cycle, because there are 5 weeks, and it expires so close to the end of the year, where income tax must be considered. – Not by me, but by American investors, plus the institutionals will be showing their yearly results, right?
Roni,
In a 5-week contract we do have a few extra days to enter positions and still achieve our desired initial time-value return goal range. As a guideline, I would say by Wednesday.
The main factor we may see at the end of a quarter (year in this case) is called “window dressing” where money and fund managers add winning stocks and sell losing securities to make financial statements look more successful.
Alan
Thanks again Alan,
I did go on and entered 10 trades, mostly from Barry’s bold tickers in the watch list.
I am now fully invested again.
Roni
Hey Roni,
Congrats on hitting all your November targets! Sounds like you are sitting on a lot of cash and have some shopping to do :)? I hope you picked up some things on the dip today.
Like Alan, I am bullish for this expiry. So much so I doubt I will over write very much simply because VIX is so low. When I did some call pricing I could not go much OTM to get any premium. But I hold mainly ETF’s, stocks may be a different story. I am concerned the underlying would just out run it’s coverage by a wide margin. Similar story with csp’s at the moment. So I just added positions buying today.
Seasonality is solid, the trade news today that a deal is unlikely this year is now in the pie, that can only get better if news changes and I don’t see any “December Surprise” rate hikes.
There are some year end things the managed funds do and individuals may do for tax loss selling but I doubt folks have that many losers to sell and dumping winners creates tax obligations. I may be too bullish which often does not work out well!
We all use the options selling tools differently. The important part is that we use them :). Congrats again! – Jay
Hey Jay;
Always enjoy reading your take on the market.
I am trying to read the tea leaves and what it looks likes they are saying is a couple of weeks of consolidation before resuming the bull.
Best;
Terry
Thanks for your always kind words, Terry!
To completely misquote FDR it seems to me “The only thing the market has to fear is no fear itself” :).
It’s not yet gold rush exuberance and no one is selling their house to buy Tulip bulbs! But we are at all time highs, VIX is low and there is always risk of running out of air up here at these levels…
A sideways period to consolidate is consistent with conventional wisdom and I hear that a lot too. In my speculative trading I have usually done fine being long call spreads through Thanksgiving as “Black Friday” has bullish history. I don’t now after that. I like to think the hurdles have been removed for a Santa Claus rally through the first week of Jan. and I am set up that way.
I state above my reasons for not overwriting much this expiry. But an equally compelling argument can be made for overwriting the entire farm at this point since gains are likely made in core positions and there is not a lot to lose except maybe opportunity but that is always the case.
Please take these comments as being the opinion of someone who overwrites an ETF portfolio or sells csp’s to add to it most of the time. I don’t have high turnover or use individual stocks like Alan, Roni, perhaps yourself and others do so successfully here month after month.
Differences only in style, I suspect :)!. We are all trying to use best judgement on market conditions, meet our goals and incorporate options selling to support them which likely differentiates us from most other retail hobbyists! Jay
Seasonality
Thanks Terry,
That chart says it all and I am playing the pattern. Last year an outlier due to the interest rate hikes. – Jay
Thank you both, Jay and Terry.
I did enter all my trades yesterday, and am now fully invested again.
Roni
Great Roni, thanks for sharing, I hope you have another winning expiry for Dec! – Jay
Premium members:
At the request of several of our members,. we have added 3 new files that can be referenced while on the premium member site:
S&P 500 stocks
Dow 30 stocks
Nasdaq 100 stocks
Look in the “resources/downloads” section of the member site.
Alan
Premium members:
This week’s 8-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site. The report also lists Top-performing ETFs with Weekly options as well as the implied volatility of all eligible candidates.
Also included is the mid-week market tone at the end 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
Hi guys, I would like to share a painful but valuable lesson I learned today. I bought CORT on 11/20 at roughly 16.75 and sold the 16 ITM call for 1.82. I was glad to see a significant 6.4% ROO with 4.5% DSP. The fundamentals, IBD ratings, and technicals are all solid. What could go wrong right? I put in a stop loss at 7% of my breakeven (13.88) in case something goes wrong.
A few hours later, I was shocked to see my stop loss executed and horrified when I saw that my shares were sold at 11.37 (32% drop)!!! Apparently some patent issue came out, which is not even on the news yet. My 20% GTC buyback order on the calls were executed also. Even more painful, it bounced back to 13+ shortly after, but the stop loss order has already been executed.
In retrospect, I should have:
– avoided the suspiciously high premium (even if the stock chart and fundamentals looked excellent)
– either bought a protective put (collar), or used a stop limit order instead
Fortunately, it was “only” 12% of my portfolio, but still pretty painful, because MTZ also dropped like a rock today which I also owned…
If you guys have anything else to add to salvage the valuable lessons here, please share. I believe these loss experiences make us better investors, more than the gains and wins
Ken,
99% of the time, this would have been a successful trade. Unexpected bad news is our enemy and it reared its ugly head with CORT.
I would have handled one aspect of this trade differently. Setting the 20% BTC was perfect. Tying it to the 7% share sale could have waited. Once the NBTC was executed, we could have checked the news to see what transpired causing the loss. Once we have that information, we can decide if we want to sell the stock since the 7% threshold was met, roll down, or wait for share recovery and re-sell the same option or any OTM call.
Overall, sorry for the loss but well done.
Alan