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Let’s Take a Test: Can You Answer Correctly?

Stock options is a category found in required examinations for certified financial planners. In May 2019, Richard contacted me because he was “miffed” at one of the answers provided for one of the questions in the CFP financial planner test question databank. I thought it would be a fun and productive exercise for the BCI community to analyze on the question as well.

 

Screenshot of the question presented by Richard

 

CFP exam

Question from CFP Test Question Databank

 

Now don’t peak at the answer below. First, take your time to examine the question and potential responses before giving your answer. 

 

Start your thinking

 

This is a Tough One

 

The Correct Answer

 

CFP Test Question Answer

 

Richard was seeking an explanation as to why selling a naked call (no stock was purchased first) was considered a short position.

 

Will we benefit from a declining stock in each of the 4 scenarios presented?

I. Sorting the stock: Yes. Selling at a higher price and buying at a future lower price will result in a realized profit.

II. Buying a $50.00 call option: No. Call options will decline in value if the underlying stock declines in value.

III. Writing (selling) a $55.00 call: Yes. Option buyers will not choose to exercise this option if shares can be purchased well below the $55.00 strike price. The option will expire worthless and a profit (option premium) will be realized.

IV: Buying a $45.00 put: Yes. Put value is inversely related to stock price. If share value declines, put value accelerates, creating opportunities for realized profits.

 

Discussion

All choices but II (buying a call option) will benefit from a declining stock price. So “D” is the correct choice. Writing a call is a short position in much the same way as is shorting a stock. When we sell a security that we don’t first own it is considered a short position. Did you get the correct answer? Be honest! Right or wrong, I hope this has been either a learning experience or a confirmation of what we have already mastered.

 

Your generous testimonials 

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:

Hi Alan,

I find BCI really great. So pragmatic and full of common sense. I will start managing a relatively large capital full-time in August and the BCI system will be used for a good part of the portfolio.

Best,

Didier

 

Upcoming events

June 11: Plainview New York

Long Island Stock Traders Meetup

Plainview-Old Bethpage Public Library

7 PM – 9 PM 

Free presentation

 

July 22: Chicago Traders Expo

All Stars of Options

1:30 – 2:15

Hyatt Regency McCormick Place

 

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Market tone data is now located on page 1 of our premium member stock reports.

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

13 Responses to “Let’s Take a Test: Can You Answer Correctly?”

  1. Greg June 8, 2019 4:11 am #

    Hi Mr Alan,

    I recently purchased several of your books. I’m quite please with them ! However, I find myself in a peculiar situation that I’m not sure you covered in your books(if so, I probably missed it). I’ve implemented a poor mans covered call by purchasing a LEAP followed by selling a call. Recently the market has dropped considerably causing my stock price to fall BELOW my LEAP strike price.

    When I tried to BTC my short call, I was prevented from doing so( I assume this was probably due to the stock price being below my LEAP strike price). Do you happen to know how I can recover from this situation ?

    Thanks,
    Greg

    • Hoyt T June 8, 2019 8:51 am #

      Hi Greg,

      Alan is correct in 99.99% of the situations where the issue you described might occur.

      However, there might be a third possibility. If you have multiple accounts and you did NOT use the Close button next to your position then it is possible that your order ticket went to the default account rather than the account your position was in. I have had this very thing happen to me.

      In a situation similar, but not exactly like your situation, I tried to place a BTC order at a price higher than a BTC order I had initiated at the time of selling the call. I had totally forgotten about the first BTC order and was really confused as to why the order ticket would not accept my order. I was glad nobody but me was aware of my embarrassment.:)

      As usual Alan is more succinct in directly answering your question.

      Good luck,

      Hoyt

  2. Alan Ellman June 8, 2019 6:56 am #

    Greg,

    There is no reason your short call can’t be closed (BTC). Two explanations come to mind:

    1- Did you place a limit order below the published “ask” price? If yes, enter a market order and the trade should be executed.

    2- Is there enough cash in your account to buy back the short call? Should be extremely inexpensive.

    If you previously placed a market order or a limit order at the published “ask” price and there is adequate cash in your account to fund the trade, I would call your broker and ask for an explanation.

    Alan

    • Greg June 8, 2019 1:13 pm #

      Thanks so much for responding to my question! Based on your feedback, I just had another look at why I could not execute my trade and noticed that I forgot I still had an open BTC trade(I forgot I placed a limit order to implement 20%/10% rule per your suggestion).

      However, the stock is starting to rebound now and rather than have the stock price move beyond my strike price I thought I would BTC my short call now with 2+ weeks left before expiration and buy another OTM call and perhaps another OTM(for july) near or on expiration day(6/28). Does this sound like a good strategy ?

      Much thanks again,
      Greg

      • Alan Ellman June 9, 2019 7:46 am #

        Greg,

        In the BCI methodology, when a strike moves in-the-money mid-contract, we consider the mid-contract unwind (MCU) exit strategy as time value moves to zero. The “Unwind Now” tab of the Elite version of the Ellman Calculator is quite useful in this regard. For detailed information on the MCU exit strategy:

        The Complete Encyclopedia- Classic edition: Pages 264 – 271

        The Complete Encyclopedia- Volume 2: Pages 243 – 252

        Had the opportunity presented itself to use the 20%/10% guidelines you alluded to, “hitting a double” may have been a positive outcome and possibly also the MCO exit strategy if price accelerates enough.

        This series of trades is a great example of how multiple exit strategies in the same contract month can enhance portfolio returns significantly.

        Alan

  3. Barry B June 8, 2019 9:41 pm #

    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 06/07/19.

    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

    Edit

  4. Mary June 9, 2019 9:13 am #

    Alan…… what are your feelings on trading on margin. I’m retired, trading actively for nearly 3 years. I’m keeping 40% of my $100,000+ account in cash.

    Thank you.
    Mary

    • Alan Ellman June 9, 2019 6:26 pm #

      Mary,

      There is no one correct answer to this question. I believe that margin accounts can be appropriate for experienced, sophisticated investors. However, in my humble opinion, margin accounts should not be used by most retail investors. Some sophisticated option strategies, however, require margin accounts.

      Here is a link to an article I published on this topic:

      https://www.thebluecollarinvestor.com/margin-accounts-and-covered-call-writing-2/

      Alan

      • Mary June 10, 2019 4:04 pm #

        Thank you, Alan!

        As with all your tutorials, the link made margin very easy to understand.

        Mary

  5. Jay June 10, 2019 10:00 pm #

    Hey Friends,

    It’s funny I have been such an old buzzard around here I recognize newer contributors like Greg and Mary as such 🙂

    Welcome one and all.

    Hoyt, I won’t pry but if you get any updates on your “peepers” please keep us posted! I’m keeping it light since I know you will be fine.

    I have about 10 positions over written for June. Some are now ITM. I never saw that coming! This market has turned on a dime. Since I only trade options in my IRA tax issues are not relevant so I will wait until Friday afternoon the 21st to see where things are. A successful new week to all. – Jay

    • Hoyt T June 11, 2019 9:14 am #

      Hey Jay,

      You must be physic. The follow up to my surgery was real good news. I have gained three levels of sight in my right eye. The surgeon feels I will have a complete recovery of sight in that eye in about 3-4 months. I go back to the retina surgeon, different doctor, in about six weeks. Unless the hole is growing, left eye, I will not have the retina surgery. I can live with the way it is now and it had only a 50-50 chance of success anyway.

      I have failed to welcome new members to our fine group and I feel bad about that. So a belated welcome to all!:) This is the most educational trading blog with which I have been associated.
      I had a technical analysis group back in the late 80’s which was excellent but we focused only on stocks and blogs were unknown then. We had to meet in person.

      Alan, Barry, Jay, Mario, and others share wisdom with us almost daily. The rest of us share our personal missteps , foibles and sometime successes with all so that we can learn from out mistakes and successes.

      Oh this market! On Friday, 6/7, with the VIX moving up I bought Puts on the S&P that expired Monday, 6/10. The market “should” have been down yesterday. What happened? Trump announced that the tariffs on Mexico would not be imposed on 6/10 as “planned”. As soon as I heard that, late Friday I think, I knew those S&P Puts were down the drain.

      As I stated last week I am closing more positions that I am opening and building my cash reserve. I used the upside yesterday to close three positions, two stock and one ETF. I did open one position.

      I bought $180 Calls on CRM expiring 07/19/19. Just a gamble that the sell off on the Tableau acquisition was overdone. The price may have been too high. Those holding Tableau(DATA) October $115-$125 Calls cleaned up. Look at the option chain for October ’19. No open interest to speak of anywhere but at these three prices. Over 10,000 at $120. Should have seen this coming?

      An up market today, which according to the futures seems likely, at least at the open, seems weird given the fade after 12:00 yesterday. In my humble opinion this is one of the most schizophrenic markets ever. A melt up is just as possible as a melt down. Still convinced a recession is coming. It will be interesting to see how the Trump administration fights tooth and nail to prevent it. I remember Jimmy Carter trying everything to turn things around in 1980. Didn’t work then. Primarily because of Iran. It may be that China will be Trump’s Iran.

      Good luck to all,

      Hoyt

      • Jay June 11, 2019 11:10 am #

        Thank you Hoyt,

        I know I speak for all of us in expressing relief and joy with your prognosis!

        You are not alone getting caught by this market surge in part of your trading. I have open puts and debit put spreads against the retail and energy sectors and am getting spanked at the moment!

        Since you track VIX a fun – and always tiny – trade you might want to try in the last hour of the cash market on M/W/F if you see VIX moving counter to the rest of the day is what I call my “Lotto” trade.

        The idea and term are far from original but it makes a tiny bet you are completely comfortable losing betting on a directional move into the cash market close. I use SPY or SPX M/W and QQQ on F with expiration in less than hour so I am trading intrinsic value. Anyway, it’s not called the “Lotto Trade” for nothing :)! It’s just a fun little gamble at the end of the day if you are following the market closely a few days a week. Doubles and triples in less than a half hour are common and I don’t care if I take a 50% stop out. The biggest moves often happen in the last ten minutes so I have orders pre-qued to click on. I am sure my broker loves me :)!

        I read a nicely researched article about how Trump’s pain tolerance for S&P declines is around 2650. When the market is higher he threatens tariffs and does tough trade talk. When it reacts to that and drops he Tweets more conciliatory things walking back the tough talk to prop it back up again.

        I guess one could make bank selling condors a few weeks out with the wings at market highs and Trump lows and keep rolling them :)? – Jay

  6. Terry June 11, 2019 11:04 am #

    Alan;

    I have a question about last weeks blog on stock repair strategy (I hope it’s not too late):

    Your setup:

    Buy FDX at $235.00

    12/7/2018: FDX trading at $201.39
    Buy 1 x $200.00 call at $10.90
    Sell 2 x $210.00 calls at $5.45

    I see three scenarios at expiration:
    – FDX trading at less than 200
    – FDX trading between 200 and 210
    – FDX trading above 210

    So what action needs to be taken at expiration?

    – If FDX trading at less than 200, do you STC the 200 call prior to expiration and are left with the 100 original shares? Do you have to tell your broker not to exercise the call?

    – If FDX trading between 200 and 210, do you STC the 200 call prior to expiration and the 100 original shares?

    – If FDX trading above 210, is every thing unwound for you by the broker and you are left flat? Do you need to take any action?

    Best regards;
    Terry

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