Locating stocks for covered call writing and put-selling is the first step as we prepare to execute these income-generating strategies. In the BCI methodology we use a three-pronged approach to screening for these underlying securities:
- Fundamental analysis
- Technical analysis
- Common sense principles (like minimum trading volume etc.)
In my books and DVDs I encourage all option-sellers to consider other screens that meet their personal risk-tolerance and trading style. Recently, a few members have inquired about using stocks selected by Jim Cramer for his charitable trust portfolio. This gave me an idea that it would be both an enjoyable and an educational experience to set up a hypothetical portfolio derived from this resource. We must keep in mind that whatever process Cramer uses to select these stocks, they are intended for a longer-term buy-and-hold portfolio, certainly a much longer time frame than our one-month option trades. That said, it is apparent that many feel that there is a high-quality feel to his selections so why not see how we can apply our covered call writing skills to a percentage of these securities? The statistics used for this article were generated on 2/3/2016.
Stocks in the charitable trust on 2/3/2016 and calculations
There were 28 stocks on the list and because the overall market was down about 9% over the past three months, most technical charts of these stocks showed bearish trend and momentum indicators. I selected the eight stocks with the most favorable chart patterns to use in a hypothetical portfolio funded with $100,000 cash. Here are the selected securities (left column):
Covered Call Writing Portfolio Selected from Jim Cramer’s Charitable Trust List
The following steps were used to determine the number of shares to be purchased in 100 share increments:
- Assign $12,000.00 per position understanding that some cash must be remaining for possible exit strategy execution
- Divide the price-per-share into $12,00.00 and round to the nearest 100
- Calculate the total cost of purchasing the shares and adjust a position if necessary
- Check the options chain for premiums generated for near-the-money strikes (I used out-of-the-money)
- Calculate the total premiums generated from selling the call options and percentage returns
Calculation results
$2165.00 in premiums were generated on a cost basis of $94,992.00 resulting in a 1-month initial return of 2.3%, annualized to 27.3%. $5008.00 remains in our brokerage cash account if needed for exit strategy execution. Some of the total cash ($7173.00) from premium plus amount not used to buy shares can be used to buy additional shares and sell call options on those newly acquired shares as long as at least $2000.00 remains in the cash account if position management opportunities arise.
What does the Ellman Calculator tell us?
Purple field- The breakeven column subtracts the total option premium from current market value and shows the point below which we may start losing money
Brown field– This column shows the time value initial return for each position. As a whole, these returns calculate to a portfolio initial return of 2.3% for the one month.
Yellow column– Since we sold out-of-the-money strikes we have the potential for additional profits from share appreciation of between 1% – 2% as shown in the chart above.
Discussion
There are many resources that can be used to locate stocks for option-selling based on personal risk tolerance and trading style. In my view, the BCI methodology is one of the elite ways to locate option-selling stocks but it certainly isn’t the only resource where success can be achieved. In this article we investigated stocks from Jim Cramer’s charitable trust and demonstrated that these securities do offer significant initial returns. Of course, no matter where a stock is located, once a position is entered we must be prepared with our exit strategy arsenal as position management is just as important as stock and option selection.
Coming in July
The Blue Hour
The Blue Collar Investor presents The Blue Hour concept inspired by this photo by Scott Evers
The blue hour is the period of twilight during dawn each morning and dusk each evening when the sun is a significant distance below the horizon and the residual, indirect sunlight takes on a predominantly blue hue (typically 40 minutes in length).
The BCI team will use this theme to provide additional educational content to our members in the form of webinars, Q&A, interviews with experts and much more. Our initial 30 – 40-minute trial run will be held on July 28th at 9 PM ET in the form of a webinar with Q&A and additional comments. I will be hosting the webinar and Barry Bergman, the BCI Director of Research will be responding to your questions simultaneously. This event will be free to the first 50 premium members who sign up and will be recorded and available on the premium member site and free to all our premium members. We will be providing a series of these educational events to our premium members throughout the year. Our team is in the process of developing a landing and signup page for The Blue Hour and once ready we will open up registration. Ultimately, the development and format of The Blue Hour will depend on your suggestions and feedback.
Next live event
June 11, 2016
American Association of Individual Investors
Research Triangle Chapter
Raleigh/Durham, North Carolina
10 AM – 12 PM
- Minutes of the April Federal Open Market Committee meeting demonstrated that the Fed would like to raise rates at either its June or July meeting, conditions permitting
- 2nd quarter US growth looks stronger while the April US employment report was slightly weaker than forecast two weeks ago as several recent data points show an increase in both economic activity and inflation
- US industrial production rose 0.7% in April
- The Consumer Price Index rose 0.4%, the strongest monthly reading in more than three years
- Housing starts rose at a stronger-than-expected rate of 6.6% in April
- Building permits rose 3.6% from the previous month
- Japan reported a robust 1.7% annualized rate of growth in gross domestic product in the first quarter of the year
- Tentative deal to relieve the Puerto Rico debt crisis reached The US Department of the Treasury and Republicans in the US of Representatives House have reached a tentative deal to set up a financial control board to take charge of Puerto Rico’s debt crisis No US federal funds are being committed as part of the package.
- Saudi credit rating cut by Moody’s Moody’s Investors Service cut its rating on Saudi Arabia’s debt to A1 from Aa3 However, recently announced economic reforms could lead to a higher rating over time, the agency said.
- China reported somewhat weaker than expected economic data this week
- The European Central Bank’s bond buying program is beginning to run up against purchase caps in government bonds issued by some of its member countries
- Philippines dislodges China as Asia’s fastest-growing economy as economic growth in the Philippines expanded at 6.9% in the first quarter, the fastest pace in that country since the 1970s
- China’s growth slipped to a 6.7% annual rate in the same quarter
THE WEEK AHEAD
- A meeting of G7 finance ministers and central bankers concludes Saturday, May 21st in Japan
- Japan releases trade data on Monday, May 23rd
- Flash purchasing managers’ indices are released globally on Monday, May 23rd
- Germany’s Ifo releases its business climate survey on Wednesday, May 25th
- Q1 UK gross domestic product is reported on Wednesday, May 25th
- Revised Q1 US GDP data are released on Friday, May 27th
Summary
IBD: Uptrend under pressure
GMI: 0/6- Sell signal since market close of May 4th
BCI: Neutral selling an equal number of in-the-money and out-of-the-money strikes.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
Alan,
I,m trading a VIRTUAL account with Optionxpress . On 5/10 I purchased 800 shares of GDX @ 24.04 and STO 8 lots of the MAY 24 STRIKE. On expiration Friday GDX CLOSED @ 24.05 AND I JUST ASSUMED MY 800 SHARES OF GDX WOULD HAVE BEEN CALLED AWAY(ASSIGNED). TO MY SURPRISE WHEN I REVIEWED MY VIRTUAL ACCOUNT ON SATURDAY 5/21 GDX HAD NOT BEEN CALLED AWAY BUT REMAINED AN OPEN POSITION IN MY ACCOUNT. I HAD SEVERAL OTHER POSITIONS WHICH UNDERSTANDABLY HAD BEEN ASSIGNED BUT NOT THE GDX POSITION, CAN YOU PLEASE EXPLAIN WHY THIS HAPPENED.
THANK YOU,
DAVID
David,
This is a head-scratcher. I’ll respond with my best (educated) guess. There is always the remote chance of a platform system error but probably not. That aside, the rule we go by is known as “exercise by exception” sometimes mistakenly called “automatic exercise”. “Exercise by exception” is an administrative procedure used by Options Clearing Corporation (OCC) to expedite the exercise of expiring options by clearing members. In this procedure, the OCC exercises options that are in-the-money by $0.01 or more unless there are other specified threshold amounts or unless the clearing member submits instructions not to exercise these options.
Since the $24 strike is in-the-money by $0.05, we would expect exercise unless the threshold for this virtual platform is greater than $0.05. I suggest calling Optionxpress and ask where the threshold is set and if less than $0.05 ask why exercise did not occur. If different from my thoughts, please let me know.
Alan
Premium Members,
This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member website and is available for download in the “Reports” section. Look for the report dated 05/20/16.
Be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar Investor YouTube Channel. For your convenience, the link to The Blue Collar Investor YouTube Channel is:
http://www.youtube.com/user/BlueCollarInvestor
Best,
Barry and The Blue Collar Investor Team
Alan
I brought stocks of BSX($22.15) and MPW($14.00) last week after reviewing your list. This week both of them failed to make it. I have not yet sold the options, and was hoping to do it this week. Now should I sell them or should I go ahead and sell call options for June 17th?
If we brought a stock which passed last week but failed this week and we haven’t sold the call option yet, should we sell the stock or should we go ahead and sell call option?
thanks
Anoop
Anoop,
Two points relating to your scenario:
1- When buying stocks for purposes of selling covered calls, it is best to write the call when the shares are purchased such that the returns meet our initial goals.
2- Once a covered call position is entered, it is managed as described in my books and DVDs NOT based on its removal from our most current stock or ETF reports.
The reason a stock will be removed from our list of elite-performers between earnings reports is usually because of a technical breakdown as shown below for BSX where there is negative volume divergence (see pages 69 – 71 of the Complete Encyclopedia Classic) and bearish MACD Histogram and Stochastic oscillator signals. If this were a stock we decided to use in our current portfolio for covered call writing, we would favor in-the-money strikes for the additional downside protection.
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Alan
Thanks Alan, learning.. I sold out BSX and MPW this morning without any profit or loss. I traded them with NVDA and CBPX, 100 shares each. I am beginner and learning, so don’t want to risk too much. Now trying to do call options and see where it goes.
Another question, some of the stocks, say MIDD, seems very good but expensive for novice like me. If I buy 100 shares, it will be in access of 12K. What strategy will you recommend if you don’t have too much cash but have good vibe about a company? Buy to open ??
thanks
Anoop
Anoop,
One low-cost way to fund a covered call portfolio is to use ETFs, a strategy I use in my mother’s portfolio. Here is a link to an article I published on this topic:
https://www.thebluecollarinvestor.com/exchange-traded-funds-funding-option-selling-portfolios-with-etfs/
Alan
Thanks Alan. Good advice. I brought some XME, aren’t doing too well but I do have some covered calls on them. Hopefully, they will recover. I do feel China slowdown is over blown, sometime by end of this year or early part of next year, the market should see uptick in commodities, specially energy and iron ore.
thanks
Anoop
Alan,
How often are you planning to do these blue hour seminars…love the idea.
Thanks
Steve
Steve,
Our plans are to host a minimum of 6 and possibly up to 10 of these webinars/interviews/Q&As per year depending on member feedback.
Alan
Hi Alan,
My name is Chris and i live in Sydney Australia and am interested in further education regarding your strategies,have written some covered calls here in Australia but the premiums are just not good enough.
can you suggest what training is offered with your group and some options.
Best Regards Chris..
Chris,
We have many members from Australia…glad to have another.
Start with our free beginners Corner tutorial:
https://www.thebluecollarinvestor.com/beginners-corner/
Our most popular and comprehensive educational package:
https://www.thebluecollarinvestor.com/package-complete-encyclopedia-dvd-series-1-month-free-membership/
Plan B:
https://www.thebluecollarinvestor.com/alan-ellmans-complete-encyclopedia-for-covered-call-writing-scover/
For 1-on-1 mentoring:
https://www.thebluecollarinvestor.com/investment-coach/
Membership/stock and ETF reports and much more:
https://www.thebluecollarinvestor.com/membership/
For free calculators and other free resources:
https://www.thebluecollarinvestor.com/free-resources/
Welcome to the BCI community.
Alan
Alan,
Would you consider this chart a “no go” because:
1 The MACD is negative.
2. The SLO STO is below the trigger line.
??
Or…
Would (since they are barely “negative”), watch it, because:
1. 20Day EMA is above 100Day EMA.
2. Price is above 20Day EMA.
3. At this time their is positive volume.
Thanks in advance
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Terrance,
Assuming this security meets our fundamental and common sense screening requirements, I would view this chart as having mixed technicals and would favor in-the-money strikes if I included it in my current portfolio.
Alan
Alan,
What is the best procedure;
Once my original strike price has expired and my stock is below its originsl purchase price lets say by $6.00, would it be better to sell the stock take the money and start over, or stay with the stock and try to make some additional writes hoping not to be called at a strike so off its original strike price?
Sincerely,
Anthony
Anthony,
A $6 decline in share value would be no big deal for a $200 stock but a huge deal for a $50 stock (3% vs 12%). If it were a $50 stock and it is still in our portfolio, we would have rolled down at least one time maybe more to mitigate losses and now be at a lower cost basis.
Now, after expiration the actual stock doesn’t matter to us, it’s the cash invested in that stock that does matter a lot. We ask ourselves “where is that cash best placed” Depending on the percentage decline, chart technicals and comparison to overall market performance we make our decisions. Every case must be evaluated on its own merit but in a general sense that $50 stock will usually be eliminated and replaced while the $200 stock will probably retain a spot in our portfolio.
Alan
Alan,
Jim Cramer has not taught me as much as you have but I find him a sharp market mind and wonderful entertainer, His portfolio is always relevant. Thanks for a great article!
It underscores a more important point: no matter whether you use Cramer, the Dividend Aristocrats or the top S&P holdings if you hold high liquidity name stocks and sell calls you will enhance your yield.
Stocks suffer herd mentality. Studies show 75% follow the trend. Or does the trend follow 75% of the stocks :)? In any case, lock step is real in both directions.
There will always be exceptions. You and Barry are skilled at identifying them!
I have found if I hold a batch of stocks I know, use the option selling discipline you teach, steer around earnings and div dates and flex my strike prices I get through the prairie dust the herd kicks up more often than not :). – Jay
Hi Jay,
I agree 100%.
The only question is : Who is the herd?
Hedge funds? Mutual funds ? Institutionals ? Retail ? Everybody ?
I wonder…….:-)
Roni,
Pogo the possum once said
“We have met the enemy and he is us.”
So I suspect we are all indicted in the crime :). – Jay
Yes Jay, we are, but as Alan says in his books, we little guys don’t move the needle.
So, the herd of whales is always in charge and move slowly.
The herd of sharks moves fast, and takes big chunks.
The small fish hide in caves.
Sardines get cought in the net.
That’s a skillful answer to a difficult question
Alan,
I don’t understand ex dividend date influence on covered calls. Help.
Dana,
Here is a link to an article I published on this topic:
https://www.thebluecollarinvestor.com/why-do-call-buyers-exercise-early-prior-to-the-ex-dividend-date/
Alan
Had a great time speaking to an outstanding group of high school finance students at Syosset HS in NY.
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Alan
Hi Allan,
I’ve been trading Covered calls in Australia for a couple of years. My early training taught me to use a protective Put (insurance) to manage risk.
I know you prefer to use portfolio management instead to do this in order to receive a better ROO but you are awake to watch what’s happening throughout the day where as in Australia we are asleep.
Do you have any thoughts on this?
Arianne
Arianne,
There is absolutely nothing wrong with using protective puts. Lower returns are accepted for the protection against catastrophic loss. I prefer more proactive position management but that is more a trading style and not a “right or wrong” commentary.
If we cannot be in front of our computers during trading hours (most Blue Collar Investors) we can also set limit orders immediately after entering a covered call trade, instructing our brokers to buy back the options at 20%/10%. From there we can decide how to manage the long stock position (sell a lower strike, wait to “hit a double”, sell the stock etc.)
Alan
Hi! Alan
I hope you are doing well ….
I have a question.
Since a few weeks I trade now the covered calls in combination of verticals. You get les premiums but the upside is open.
I write a covered call and add a long call above the call I sold.
Therefore I have no problem when the stock rally…..of course I have less downside protection.
I use this strategy on stocks I will keep for years in my account (t, so, duk, mo, vz etc).
Your thoughts on this while you never spoke or rode in your books about this.
Have a nice day.
Marc from Luxbg / Europe
Marc,
It’s that “of course I have less downside protection” part that doesn’t work for me. The long call aspect requires that Delta overcomes Theta. Although there is opportunity to win big, there is an initial disadvantage that I am not comfortable with. This does not make it wrong for everybody. Naked option trading may be appropriate for those with a higher risk-tolerance than I have. My way isn’t the only way.
We have some members who trade covered calls in their main investment portfolios and then have a small, higher-risk portfolio for trading naked options…perhaps using non-essential cash.
Alan
Premium members:
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https://www.thebluecollarinvestor.com/member/login.php
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Alan and the BCI team
I have accumulated a number of shares of SPY. I have lumped my bookkeeping for covered calls, cash covered puts and an occasional iron condor together to come up with a cost basis. It is substantially below the current price of SPY. My question is what strikes make the most sense to sell given my situation? What I’ve done the last few months is to sell some slightly in the money, some at the money and some out of the money.
Thanks
Spencer,
The first step is to define our goals. It appears that in this case you want to generate as much income as possible while not having the options exercised. We also must decide what minimum returns we are looking to generate to make this strategy worth our time. Now , for SPY, selling a near-the-money strike will generate a 1-month initial profit of about 1%. The deeper out-of-the-money we go the less likely is exercise and the lower are our returns. Let’s say we are seeking a 1-month 0.5% minimum return We look at an options chain for the deepest out-of-the-money strike that returns about $1 and now we have found our most appropriate strike. We also must be prepared to roll the option if in-the-money as expiration approaches.
Alan
Alan
Question, say I buy a 100 stocks, 1 contract for $20. I have also sold out-of-money option for 0.60 with strike price of $22. My contract expires on June 17, which is Friday. On June 17th morning, lets say stock price is 20.50, and I know my contract will expire. Now, I don’t want to wait till Monday morning. I know by end of the day my contract will expire. So should I just sell the stock at 20.50 and wait till Monday morning, or should I wait till Monday and then sell my stock @whatever price..? Buying back my options before selling might entail some fees ??
Issue is what should I do on the expiration day, when I don’t want to take a chance till Monday morning as some weekend news might crash the market and my stock will open at say $19 ?
thanks
Anoop
Anoop,
If a strike is out-of-the-money as expiration approaches and there is concern of a potential share decline over the weekend, we buy back the short call first and then sell the stock at market value. The additional cost to close over the commission to sell the stock is the time value remaining on the OTM strike + the commission, say about $15.00 per contract.
That $15.00 can be saved by waiting until Monday after the option expires worthless and shares open higher, lower or the same as the pricing that existed on late Friday.
Alan
Alan:
I ran a spreadsheet on the Cramer transactions, using the March 4 expiration day closing price. 5 of the stocks paid dividends during the period (WFC was purchased on the ex-date). These would be received by a buy and hold buyer or a covered call writer. I assumed covered stocks were held to expiration.
Covered Call profit was (Lower of strike or expiration value)minus (stock cost less premium received) plus dividend=$2,105 or 2.3%.
Buy and Hold Profit was (Value on expiration day)minus (Stock Cost) plus dividend=$3,628 or 3.8%.
It didn’t seem to matter whether a dividend was paid or not. The Covered Call Portfolio was, of course, less volatile.
I didn’t simulate management. If I had been able to, what might I have done in actual practice to bring the Covered Call return closer to Buy and Hold?
Peter
Peter,
There are 3 required skills for covered call writing. Stock selection, option selection and position management. Let’s review the exercise you are sharing (and thanks for taking the time to do it):
Stock selection: We are using a portfolio of Cramer stocks with decent chart patterns. His selection process is based on a longer-term buy-and-hold strategy that may not be the best for 1-month covered call writing although I did think it a fun exercise since many of our members watch his CNBC program. I will assume, though, a solid portfolio to start with.
Option selection: The past 3 months have been relatively bullish with many whipsaws…the S&P 500 up about 7%. Deeper out-of-the-money strikes would have generated the highest returns. I would lean in this direction when charts show bullish signals which was the stating point I used when selecting this portfolio.
Position management: I can’t understate how important it is to take advantage of the whipsaws in price movement. Buying back and re-selling options, closing positions that have maximized their potential returns etc. will elevate returns to the highest levels and set us apart from all other covered call writers.
Thanks for sharing.
Alan