Never sell a covered call or put option when there is an earnings report due to be reported prior to contract expiration. I have repeated this rule so many times over the years because I want our members to avoid the losses I incurred back in the 1990s before I realized how important it was to integrate this guideline into our methodology. For traditional option-selling, we can simply remove stocks about to be report from our portfolios and add them back in after the report passes if the security still meets our system criteria. Frequently, there are situations when we want to retain the shares in our covered call portfolios but still want to avoid the risk of capping the upside (with the call strike) while still being exposed to the downside.
Reasons for retaining shares through an earnings report
- Shares were purchased at a much lower cost-basis and is in a non-sheltered account exposing investors to negative tax consequences, if sold (see portfolio overwriting)
- The stock has a history of positive earnings surprises and we are confident that risk to the downside is limited
- We simply like the stock and have no intention to sell
Does the rule (of not selling the option) still apply if we choose to retain shares through an earnings release?
Yes. We do not cap the upside prior to the report. Statistically, we will benefit more often than not from positive reports compared to suffering from negative surprises. The argument for writing the call is that the premium will somewhat mitigate a loss from a disappointing report. Let’s take two $50.00 stocks to create a hypothetical. Both stocks return a 2%, 1-month premium return for selling the $52.00 strikes ($1.00 per share). Stock A has a positive report resulting in a 10% price gain to $55.00. Stock B has a disappointing report and suffers a 10% price decline to $45.00.
Writing the calls prior to earnings
- Stock A: $1.00 + $2.00 (share appreciation from $50.00 to the $52.00 strike) = + $3.00
- Stock B: $1.00 – $5.00 (share depreciation from $50.00 to $45.00) = – $4.00
- Net loss of $100.00 for the combined positions
Avoid writing the calls prior to the report
- Stock A has a share appreciation of $5.00
- Stock B has a share depreciation of $5.00 per share
- Net combined position results in neither a loss or a gain
Over the past decade or so, there have been more positive than negative surprises as more companies will provide muted guidance so as not to disappoint or may pre-announce prior to earnings if results are not meeting previous guidance. This means that by avoiding earnings reports will average out even better results than the hypotheticals presented. This has been my personal trading experience for over two decades now.
NKE has earned its way onto our Premium Member Blue Chip (Dow 30) reports for the first half of 2018. After expiration of the June contracts, we were faced with an upcoming earnings release on 6/28/2018. The report was positive as reflected in the screenshot below:
Note the following:
- From mid-November through the end of June, NKE (brown line) out-performed the overall market (blue line)
- On 6/29/2018, NKE enjoyed an $8.00 per-share price increase, a result of the after-market close earnings release on 6/28/2018
- Over the past 1-year, the S&P 500 was up close to 15%, while NKE appreciated by 45%
How to best manage this situation
- June contracts expired on 6/15/2018
- Write a Weekly call option on 6/18/2018 expiring on 6/22/2018
- Skip writing any calls the week from 6/24/2018 through 6/29/2018
- 7/2/2018: Write the monthly call for the July contracts expiring on 7/20/2018
- This will result in capturing 4 weeks of time value while still avoiding the risk of capping the upside through the earnings release
Never sell an option for contracts expiring after an earnings report. Weekly options, when available, can be useful to circumvent these risky scenarios. When Weekly options are not available, we can simply write the monthly option after the report passes. When the report is due out near contract expiration (with no available Weeklys) we may need to just pass on writing the option that contract month.
February 7th – 10th, 2019
Orlando Money Show
Omni Orlando Resort @ Champions Gate
February 7th – 10th 2019
1. Getting Started with Stock Options: Creating Monthly Cash Flow with Covered Call Writing
February 8, 2019, 3:10 pm – 3:40 pm
2. Getting Started with Stock Options: How to Select the Best Options in Bull and Bear markets
February 9, 2019, 2:00 pm – 2:45 pm
Your generous testimonials (new feature)
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:
You have no idea how much your YouTube lessons have meant to Brenda and myself financially.
Investment of $100,305.45 grew to $106,272.16 = $5,966.71 0r 6.28% from July 17 – August 29,2018
This week’s economic news of importance:
- Chicago Fed national activity index Nov. 0.22 (0.00 last)
- Case-Shiller home prices Oct. 5.5% (5.5% last)
- Weekly jobless claims 12/22 216,000 (217,000 expected)
- Consumer confidence index Dec. 128.1 (133.3 expected)
- Chicago PMI Dec. 65.4 (66.4 last)
- Pending home sales Nov. -0.7% (-2.6% last)
THE WEEK AHEAD
Mon Dec. 31st
- None scheduled
Tue Jan 1st
- None: New Year’s Day
Wed Jan. 2nd
- Markit manufacturing PMI Dec.
Thu Jan. 3rd
- Weekly jobless claims 12/29
- ISM manufacturing index Dec.
- Construction spending Nov.
Fri Jan. 4th
- Nonfarm payrolls Dec.
- Unemployment rate Dec.
- Average hourly earnings Dec.
- Markit services PMI Dec.
For the week, the S&P 500 moved up 2.86%% for a year-to-date return of -7.03%
IBD: Market in correction
GMI: 0/6- Bearish signal since market close of November 13th, 2018 as of Friday morning
BCI: Selling only in-the-money strikes; 25% of my stock portfolio net worth in cash. Still confident in the fundamentals of the US economy and plan to put the cash on the sidelines back to work once the volatility subsides.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
The 6-month charts point to a bearish tone. In the past six months, the S&P 500 down 8% while the VIX (28.30) moved up by 68%, both improvements over last week.
Wishing you the best in investing,
Alan and the BCI team