Covered call writers must understand and evaluate the success (or lack thereof) of our trades. Simply stated, are they winners or losers? In June 2019, Van shared with me trades he executed with the exchange-traded fund (ETF), Energy Select Sector SPDR Fund (NYSE: XLE). He was trying to categorize his trade as a winner or a loser. This is a common confusion as we are in 2 positions (long the stock and short the call option) initially with 1 or both closed at some point. This article will evaluate Van’s trading history with XLE.
Van’s trades
- 5/20/2019: Buy 500 x XLE at $63.78
- 5/20/2019: Sell 5 x $64.00 6/21/2019 calls at $1.00
- 6/3/2019: XLE trading at $59.52
- 6/3/2019: Buy-to-close the $64.00 calls at $0.02 (no further action taken on option side as of his email contact with me)
- 6/23/2019: XLE trading at $63.56
Realized versus unrealized gains and losses
When some retail investors buy a stock (no option component) and price moves down, there is a hesitancy to sell because (the feeling goes) it is not a loss until the stock is sold. If the share price accelerates, we have a paper gain but that profit isn’t credited until shares are sold. In this same vein, when we sell a covered call or cash-secured put, I define this return on option (ROO) as initial time-value profit… notice the word initial.
When an option is sold and then either closed (buy-to-close), expires worthless or is exercised, that option trade results can be calculated as realized. Until one of those 3 outcomes transpires, it is unrealized. The same holds true for the stock side of the trade… until the shares are sold, gain or loss is unrealized or yet to be determined.
Initial structuring of Van’s trade using The Ellman Calculator
XLE Initial Return on Option
The initial 18-day time-value return is 1.6% (32.4% annualized) with a possible additional 0.3% if share value moves up to the $64.00 strike by the 6/21/2019 expiration. Since neither position is closed, these are unrealized returns but do define the initial structuring of the trade.
Status of trade on 6/3/2019
Option: The short call was closed (BTC) at $0.02 for a net realized profit of $0.98 per-share, $490.00 for the 5 contracts.
Stock: The stock side is still open. The per-share unrealized loss is $4.26 per-share or $2130.00 for the 500 shares.
Opportunity to “hit a double”
After closing the initial short call, no other options were sold by contract expiration. As Blue Collar Investors, we should always evaluate our trades and ask ourselves if we could have done better. Perfection is a goal we seek but can not always achieve. But we should try to come as close as possible. Between 6/3/2019 and contract expiration on 6/21/2019, share price moved up creating opportunities to re-sell the original option. The chart below graphically shows how additional option premiums may have been generated.
Price Recovery of XLE in Brown Field
Status of trade on 6/23/2019
The share unrealized loss at this point in time is $0.22 per-share or $110.00 for the 500 shares. If shares were sold on this day, the combination of option and share realized results would calculate to a credit of $380.00 ($490.00 – $110.00) on a cost-basis of $31,890.00 ($63.78 x 500) resulting in a 34-day return of 1.19%, 12.8% annualized. However, the shares were not yet sold meaning that the final chapter was yet to be written. The one thing that is etched in stone is that Van is $490.00 better off having written and closed the option and probably could have done even better had a second option been sold during the subsequent share appreciation.
Discussion
When evaluating the results of our option-selling trades, we must define and categorize the realized and unrealized conclusions. In the long-run, option-selling lowers our cost-basis and that is why we should beat the market every single year. For those who purchased XLE and didn’t sell the option, there would be an unrealized loss of $110.00. Van had a realized gain of $490.00 on the option side, leaving an unrealized gain of $380.00 as of 6/23/2019 when viewing both legs in total.
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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,
You are a gifted man. So willing to share your passion. Thank you.
They say, “Easy reading is the product of hard writing”. Your writing connects with me. A gifted writer/communicator, you are.
Many blessings,
Ron S.
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Hi Alan,
I have another question on one of the downsides of writing covered calls:
You mention in your videos, that one downside is that if the price of the stock drops below your breakeven point you start to lose money. Isn’t it true that if you don’t sell the stock (and you’re not obligated to if it doesn’t reach the strike price), you don’t actually realize a loss?
If you are perfectly fine holding the stock long-term, than the “downside” is actually that it ties up your money with that particular stock (unless you are willing to realize the loss and you sell it).
Is my thinking correct or am I missing something? That is one point I have been getting confused on.
Thanks!
Dave
Dave,
You are 100% correct that a gain or loss on the stock side is not realized until the shares are sold. When evaluating the pros and cons of covered call writing, it is important to factor in where we stand on the stock side whether realized or not. We are, however, less exposed to the downside in our overall portfolio because we are selling options.
If we take stock losses out of the equation, the main disadvantage of covered call writing is that share appreciation is limited by the option strike price.
Every strategy has its advantages and disadvantages. We must analyze these and make sure they meet our overall return goals, trading style and personal risk-tolerance.
Alan
Fear and Greed Index is now at 91.
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 12/20/19.
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
Best,
Barry and The Blue Collar Investor Team
barry@thebluecollarinvestor.com
To All,
Reminiscences of a Stock/Option Operator (with apologies to Edwin Lefèvre)
As an investor (including a stint as a pension fund manager), a speculator and a trader of stocks and options for over 40 years I have, as everyone does, reminiscences. Now in the twilight of my life, note I didn’t say career, I began this activity rather late in life, rather than bore others with my reminiscences I thought I would share some trading principles I have learned over the years. Many came at a high cost in both dollars and stress.
1. View trading as a vocation(job), not a game.
2. Options are the vehicle. Equities and ETFs are only a means to options. Choosing the appropriate equity or ETF is extremely important.
3. Be a seller not a buyer of options except, of course, for spreads. Time decay is on the side of the seller. At least be a net seller even if you must, from time to time, speculate. Even then sell the bought calls rather than exercising them. Even in speculation choosing the appropriate equity or ETF is extremely important.
4. In selling an option the risk is in the underling not the option.
5. Have a “system” for taking profits, mitigating losses or even speculating.
6. Follow the system.
The BCI methodology is the system most traders should use. If you follow it methodically you will train yourself not to fall in love with individual stocks, not to use hope as a reason to hold poorly performing stocks and not to let greed lead you to making a poor decision.
In my speculation I have made, over and over, two major mistakes. I have not cut my losses soon enough(hope) and I have not taken my profits soon enough(greed).
To mis-quote Winston Churchill, there is nothing like losing one’s rear to focus one’s mind.
My New Year’s resolution, as for options trading, is to place stop loss orders when I enter a trade. That should care of most of the “hope” problems. I have yet to come up with the greed solution.
By the way the BCI methodology takes care of both of these “problems” if properly followed.
I am very thankful for all Alan, Barry and the staff do, especially providing us the opportunity to share thoughts and comments on this blog.
I wish all of you the Happiest of Holidays and the most Prosperous of New Years.
Hoyt
Hoyt,
Thank you for your mentoring to everyone on our blog!
I call it “our” blog because I believe those here should regard it as something they take ownership in. Please, everyone, share openly and “risk” sharing the “dumbest” trade you ever made along with the “smartest”! And ask any question because it will teach us all as we share this journey to get better at something we value: managing our own money.
Which brings me back to Hoyt’s point #1: I do better if I view this as a business I own striving to improve every day. It’s not quite the same as a hobby like golf or tennis where I don’t care as much since it is just for fun and exercise :).
More to point for this thread many have heard the expression “Beauty is in the eye of the beholder” ? To have a fun rhyme with that “Gain is in the eye of the stock holder”. It strikes me I look at gains and losses differently through the prism of time.
If I do an option buy for tomorrow, a spread for this week, a covered call for next month, a Leap for a year from now or just keep marching on with a portfolio over write/csp campaign each result will be different.
A nice way to keep score no matter what I do is look at SPY as time goes by. Did I beat it in 2019? If not why not and what, in this business I own, will I do differently in 2020? Or keep doing if I did and adjust with the market?
I shared Holiday greetings last thread. But if redundancy is pardonable all the Best once again :). – Jay
Hey Jay,
Thanks for the kind words. You are a real gentleman.
As Alan said in the last blog you have made invaluable contributions over the years. I know that I personally have gained much from your insights.
Looking forward to many more years of successful learning and earning.
Hoyt
Thank you for your kind reply, Hoyt.
As usual you nailed it: learning and earning is the name of the game! Kindest regard to all BCI friends. – Jay
Hello Jay,
sorry for late reply to your kind wushes for the hollidays.
The reason is, I am in moving mode. Just bought a new “used” apartment, much closer to my office, where I am required to continue working every day (half day).
So I was separating and packing the stuff we will bring with us when the truck brings the furniture on 01/15/2020.
Later next year, we will have to separate the rest (a colossal work), to empty my home (house), so I can proceed to have it refurbished (paint, varnish, and more) and finally try to sell.
The situation in Brazil is improving slowly, but the prices for property is still very depressed.
So, Merry Christmas to you too – Roni
Hoyt,
Thank you for all the great advices and encouragements. I certainly learned a lot from all your posts.
Our age brackets are very similar, and I also started late. Very late, 10 years ago.
Therefore, your vast experience is very much appreciated.
Btw, I did read (and respond) your kind message posted 12/12 on”Ask Alan #165.
As you said, and Jay recommends, it is always good to look back at the previous thread when a new week begins.
Merry Christmas – Roni
Hey Roni,
Thanks for your kind words. My condolences on your move to the new apartment. I have only moved twice since my marriage in 1960. I hated both moves.
Every time I see one of your posts I remember the conversations we had about sailing. Particularly the one where I spoke of the hair on the back of my neck alerting me to a upcoming change in the wind. Boy, I wish I had a built in indicator about an upcoming change in the market.:)
I wish you the best of Holidays in the beginning of your Summer and I wish you every success in the upcoming New Year.
I think the US market has dodged a recession and 2020 will be a positive year. I am still 30% cash and will probably remain so. This is very unusual for me as I have always been 100% invested for most of my 40 years in the market. I think maybe I am too old to remain fully invested.:)
Best wishes my friend,
Hoyt
Thanks Hoyt,
I am 52% in cash today. Had no time to look for opportunities after last expiry Friday, and I’m not sure about the Jan 17 option cycle.
Yes, sailing was great fun. My my main boat was the “Snipe”, participated in many championships with my wife, but we were both underweight and therefore never made it to the top 20.
Before this, we also had a “Lightning”, and at the end, 20 years ago, a “Day Sailer”.
Roni
Hey Roni,
Thanks for the nice follow up and update. Sounds like you are busy!?
Having grown up in a service family then served also then joined a big company who moved me every 2-3 years that was the only life I knew until I retired. Ironically living in one place now has been an adjustment :!
Interesting time in the market. This may be the 10th session in a row QQQ closes higher – I think that is a record? Often after the “Santa Rally” seasonally prevalent thru next week I rotate out of some stock exposure and replace it with the metals. They can be correlated inversely much of the time but be acute this time of year. Tickers like GLD, GDX, SLV and PAAS work well for that if the seasonality plays out?
Looking forward to a New Year of “learning and earning”, as Hoyt would say, along with all our friends here. – Jay
Hi Jay and Roni and All,
I have been selling Bull put spreads this month. Mostly weekly and bi-weekly. Weekly and bi-weekly have very rapid time decay. Been using mostly SPY, QQQ, ADBE, APPLE, MFST. MU and other hi flyers. Only lost money on KMX. Should not have been in KMX from the get go, but ,hey, I am a compulsive gambler sometimes. It’s a costly addiction.:)
All current spread positions will expire on 12/27 and 12/31. As of now they are all under $0.05 most with no bid.
I intend to close all LEAPS on 12/31. Have 3 APPL LEAPS ladders which have gone through the roof.
I will see how the market positions itself in the first 3 days. If we get some adjustment, especially with APPL, I will re-enter a LEAPS position on APPL. I will have to decide whether to stay with Bull put spreads or to go with Bear call spreads. Both strategies have limited gains as well as limited risks. You can get into a lot of positions with limited use of funds. Not as profitable as CSPs but don’t require as much cash.
In any event it will be an interesting year, particularly the first quarter leading up to Super Tuesday.
Best wishes for a Prosperous New Year to all,
Hoyt
Since Van was willing to be long XLE there was no reason to BTC for $0.02. Just let the Call expire worthless. Why take action when it’s unnecessary and give up a small credit and a trade commission? In this case the stock price moved back up prior to expiration creating the opportunity for a double. But, if it stayed down it would have just been giving up $10 and a trade commission. Better would have been to look for an opportunity to roll the trade out for additional credit at the $64 strike if the credit was significant when the stock started to move back up.
James,
I have had my share of “lost opportunities” as did Van in this trade. The key is to learn from these and then have years and decades to benefit from these learning experiences.
In this case, buying back the short call in the first half of the contract made sense. Not re-selling the option when share price accelerated represented the lost opportunity.
Your post reflects the thinking of an elite option-seller in that you are incorporating position management into the trade strategy. Far too many covered call writers simply enter a trade and then hope for the best.
Keep up the good work.
Alan
Hi Alan,
I bought AMD one contract on December 9,
AMD bought at $39.15
Sold a Jan 10, 38.5 call for $2.16
time value $1.51 intrinsic value 0.65
Right now the AMD stock is 44.15 so the intrinsic value is higher.
I guess its 5+.65 or $5.65
Is there a way to calculate the remaining time value for this option
or any other option ?
I’m asking this question because suppose that an option has little
time value money left but it still has some intrinsic value left and since
what we keep is the time premium maybe its better to just buy the option
and sell another that has more time value?
Thanks,
Julio
Julio,
Yes, there is a way to calculate the time-value cost-to-close. It is located in the “Unwind Now” tab of the Elite version of the Ellman calculator (free to premium members).
The “ask” for the $38.50 1/10 call pre-market today is $5.90. The screenshot below shows the time-value cost-to-close is $25.00/contract or 0.65%. If we can generate at least 1% more (> 1.65%) in a new position by 1/10/20, it pays to close the entire trade and enter a new one with a new underlying security. In the BCI methodology, this is known as the “mid-contract unwind” exit strategy.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan
Alan, Barry,
Thank you for updating the Options Expiration Calendar to 2020. Very useful.
Best Wishes for the Holidays to everyone.
Mario
Hi Alan,
For large portfolios is $30,000 your suggested amount for every type of stock? Is there a maximum amount that you suggest? And how do you know what type of stocks to use and when?
Thanks,
Gilbert
Gilbert,
Here is the BCI approach for creating and funding all portfolios:
1. Determine the maximum number of positions we can comfortably manage each month (for me, it’s 15 – 25 plus a few in my mother’s portfolio).
2. Divide the number of positions into the cash available to determine cash allocated per position..
3. Divide the price-per-share into the cash allocated per position and round to the nearest 100. This will dictate the number of shares to buy and options to sell.
I select the stocks for my portfolios from the same reports we provide to our premium members based on the BCI methodology for stock screening. I select the ETFs for my mother’s portfolio from our premium member ETF reports. We also have a Blue-Chip report of best-performing Dow 30 stocks for those who are more conservative.
Alan
Alan,
In managing your covered call portfolio, do you keep a separate Ellman Calculator for each security you own on which you have active options?
Any other systems you have found works best for you?
Many Blessings!
Ron
Ron,
Most of the major online brokers have a “positions” link that allows us to follow our positions.
BCI also has a “Trade Planner”, Daily Covered Call Checkup spreadsheet and a Schedule D attached to the Elite Calculator (the latter 2 are free to premium members) to assist with portfolio management.
Alan
Hi Alan,
I hope all is well. I wanted to give you an update on my 1st year trading covered calls. I paper traded for 3 months before I went live. Every trade I made was ITM except for 3 that I guess I would consider ATM. Below are all the live trades that I made this year.
I hit a double on TTD and TEAM had an earnings date changed which led to a drop right before contract expiration but I was able to sell back a few days later at the original strike. I had emailed you about that some months ago.
Every trade was profitable. I have been involved with the stock market since 2005. I had some good times but never consistent until the covered calls. I appreciate all your videos and I literally have most of your books, ha.
My average return was 2.3% and thats entering some trades in the 2nd week of the contract cycle.
I had a question. Are these returns that I can expect in bullish, neutral and slightly bearish markets? Trying to see if this is a year I can repeat over and over. Now as my experience grows, the returns could possibly be better than these.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
-Mark
Mark,
Congratulations on your impressive success.
In normal to bull markets your percentage return is a reasonable expectation but having every trade profitable is unusual.
Each month I have a small number of losing trades (I typically hold 15 – 25 positions/month) but they have been mitigated through the use of exit strategies. Many of my winners were enhanced also by using exit strategies.
Keep up the good work and thanks for sharing.
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
NOT A PREMIUM MEMBER? Check out this link:
https://www.thebluecollarinvestor.com/membership.shtml
Happy holidays to one and all,
Alan, Barry and the BCI team
Alan,
I see you recommend subscribing for IBD access which is a sound advice. I normally buy walstreet journal and IBD once a month to identify sectors, look for the high volume optionable stocks and see if they have annual dividends with a minimum of $1.
Once i finish shortlisting this, i am thinking of starting a covered call – OTM in my paper trade to have a system which works for me.
Please let me know if i am on the right track.
Thank you
Murali
Murali,
Here are some comments/observations I hope you find useful as you launch your option-selling career:
1. In the BCI methodology we use 2 IBD screens (IBD 50 and SmartSelect) as part of our screening process. For premium members, there is no need to subscribe to the IBD services as we do the entire screening process (IBD + all other screens) for our members.
2. Adequate option liquidity is important… good observation.
3. I view stock dividends as “icing on the cake”, rather than a prerequisite for stock consideration.
4. If I focused on dividends (I don’t), I would look at yield rather than dollar amount. For example, a $1.00 annual dividend is pretty good for a $30.00 stock but not so much for a $300.00 stock.
5. OTM strikes are appropriate for normal to bull market environments and allow us to generate 2 income streams for each trade (option premium + share appreciation up to the strike). However, in bear and volatile markets I give strong consideration to ITM strikes. One of the advantages of option-selling is that we can tailor our trades to current market assessment, chart technicals and personal risk-tolerance.
Now, let’s get 2020 off to a great start for all members of our BCI community.
Alan
To All,
I apologize for over using my access to this blog.
I had a personal tutoring session with TD Ameritrade on their ThinkorSwim trading platform. It was conducted online. What was supposed to be 45 minutes ended up being 1 1/2 hours at their initiative. A very good instructor. I learned a lot. Obviously they want me to move my account to them but there were no strings attached. I currently use PowerE*Trade. Each has features that I really like. Both make spread selling very easy.
I am writing this because a the end of the session I enquired about the upcoming merger with Schwab. Of course he didn’t know which platform would survive or if both would. I don’t believe both will. Schwab will be the “gorilla in the room”. It will, in my opinion, dictate how discount brokerages operate and should have the lead as for trading platforms.
A note on the “fantastic” market today. On the NYSE there were 1,716 gainers, 1,208 losers and 115 unchanged. What does that tell us? IMHO it says the winners rose and the losers fell. Why? Fund managers want losers off the books and winners on so that their prospectus looks “smart”.
Hoyt
Hi Hoyt,
Following up on your comments, re: Think or Swim (TOS), you might want to also look into Schwab’s StreetSmart Edge (SSE). I have been an external beta tester for Schwab on the original Street Smart and the newer StreetSmart Edge. Since Schwab bought Options House, they have been incrementally improving the options capability of SSE.
I have accounts at both Schwab and TD. Since the improvements in SSE, I now only use TOS when I want to evaluate a new strategy using the “ThinkBack” feature of TOS. For everything else, SSE works well for me.
Of particular value are the new settings that can be added to the option chain. They include:
– Probabilities of closing ITM
– Probabilities of closing OTM
– Probabilities of touching the target strike
– Time value
– Intrinsic value
– All of the Greeks
– Mid-price in addition to Bid and Ask
– Probability calculator for multi-leg trades
– Excellent charting capabilities
– Plus numerous other capabilities
I don’t want to make this sound like a sales pitch… I don’t have any connection to Schwab other than being part of some of their pilot programs. Since you are looking into other platforms, you might want to check SSE out.
Best,
Barry
Hi Barry,
Much appreciate your help.
One thing I have learned in my testing of ToS is that PowerE*trade (PE*T) has more features than I knew. By the way, I believe that it was E*TRADE who bought OptionsHouse. PE*T has all of the features you listed and more. I just had not put them in my settings.
I still need to work with both to better understand how I can fully use them for my needs. In a least two areas PE*T is easier than ToS. I like ToS’ Probability Analysis which uses the standard deviation bell curve turned on it’s side overlaying different expiration dates. Real cool.
Once I get a handle on ToS and PE*T I will get SSE and give it a try. All of them are smarter than I am.:)
The fade into the close today felt a little uncomfortable. I was surprised at some of the issues fading before year end Sometimes just the lack of buying pressure can cause stocks to go down. May not portend well for some of my biggies on Monday or Tuesday.
I have $209/$208 QQQ put spreads expiring Tuesday. QQQ closed at 213.61.
Hoyt
Hoyt,
Yes…you are correct. Schwab bought Options Express, not options House. Schwab has the same probability overlay as does TOS. However, PT does, in fact, have a more intuitive display of spread parameters than does either TOS or SSE.
If you have any questions about SSE, just send them over.
Best,
Barry
Alan,
I’ve been trading some options with help of savvy options broker/friend in pretty much AI stocks.
Been doing quite well but I am 74 yrs and figure maybe time to do more ‘boring’ trades as capital preservation Is key so thanks and look forward to learning your system…am familiar with IBD and trade on TOS/Td site. John
John,
Welcome to the BCI world of low-risk self-investing. Here, we wear the term “boring” as a badge of honor. If I may define this term and its antonym (tongue in cheek to add a bit of humor):
BORING: Generate small but consistent income flow into our portfolios and beat the market every year.
EXCITING: High-risk trades where large amounts of cash are generated or lost as we watch the hair from our heads turn gray or simply fall out.
***There are exceptions to this “hair rule” as shown below.
Wishing all our members a fruitful 2020.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan