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.
Real-life example with NIKE, Inc. (NYSE: NKE)
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:
NKE and S&P 500 Comparison Chart
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
Discussion
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.
Upcoming event
February 7th – 10th, 2019
Orlando Money Show
Omni Orlando Resort @ Champions Gate
February 7th – 10th 2019
Speaking schedule:
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:
Alan,
You have no idea how much your YouTube lessons have meant to Brenda and myself financially.
Update:
Investment of $100,305.45 grew to $106,272.16 = $5,966.71 0r 6.28% from July 17 – August 29,2018
Randy P
Market tone
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%
Summary
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
Alan,
I was reading the recent blog by Kevin, retired financial planner. It was very interesting and informative.
Can you please explain with examples if possible what he meant by deep in the money calls that he did during the crash of 2008? I quote as follows:
“Their monthly cash flow would continue, and we might be called away more frequently but because were selling deep in the money calls they would be largely protected to the downside…..”
Thank you.
Vasanthi
Vasanthi,
Selling deep ITM calls in bear and volatile markets offers the advantage of the additional downside protection offered by the intrinsic value of the option premium.
ATM and OTM strikes consist of time value only and offer their own advantages but let’s focus first on a hypothetical.
Let’s say Company XYZ is trading at $52.50. The $55.00 OTM strike may generate a time-value only premium of $2.00, making the breakeven $50.50.
The ITM $50.00 strike may generate a premium of $4.50 ($2.00 in time value + $2.50 in intrinsic value- the amount the strike is in-the-money), making the breakeven $48.00.
For real-life examples, here is a link to an article I published on this topic:
https://www.thebluecollarinvestor.com/selecting-deep-in-the-money-strikes-a-real-life-example/
Alan
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 12/28/18.
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 BCI Team
[email protected]
Alan.
Thank you for the opportunity to read and absorb your Blogs and other stuff. I am particularly interested in PMCCs. I perused most of your Blogs written during the last 2 years and found many having to do with plain vanilla Covered Calls, but none about PMCCs.
I read
The 10 Most Costly Mistakes That Covered Calls Writers Make, and How To Avoid Them special report.
My question is ” Do most of those suggestions apply to the PMCCs?” My guess is that they do. I saw a You Tube that you gave re: PMCC, but am a little disappointed that there haven’t been more about the PMCCs.
Looking forward to hearing from you or your staff.
Happy New Year!
Ken
Ken,
The PMCC strategy is addressed in detail in our latest book, “Covered Call Writing Alternative Strategies”:
https://thebluecollarinvestor.com/minimembership/covered-call-writing-alernative-strategies/
We also developed a calculator for this and the other 2 strategies discussed in the book:
https://thebluecollarinvestor.com/minimembership/calculator-package/
My hope is that you find these resources user-friendly, comprehensive with every aspect of this strategy detailed with examples.
Happy New Year,
Alan
Alan,
First, happy new year. I hope you’ve had a great year.
Second, I just finished your book on exit strategies for covered calls, and I have a question. I really enjoyed the book.
I’m planning on going live in January and have been simulating in December to prepare.
I want to hold the SPY (or a blue chip stock) for 5-10 years, so I don’t want to get assigned. I’ve been practicing rolling over my covered call at expiration to keep my stock and keep collecting premium.
As you know, the SPY has dropped quite a bit and my current simulated position is deeply negative because my last rollover was in-the-money. If I buy to close, I’ll lose all my December gains.
My question: if we’re keeping the stock forever and the market drops a lot, should I sell out-of-the-money calls to keep collecting premium while I wait?
It seems like in-the-money calls are dangerous after a big drop because I might get assigned.
Any help would be greatly appreciated! I’ve watched all your videos and love the book. Keep up the good work!
Regards,
Scott
Scott,
Traditional covered call writing will result in the highest returns when selecting underlyings that are elite performers at the time the trades are executed. This generally involves changing stocks or ETFs on a regular basis as well as avoiding earnings reports.
For those of us who want to write calls against underlyings that we plan to keep for the long-term (generally for tax and/or dividend reasons) , the strategy can be tweaked to a strategy I refer to as “Portfolio Overwriting” in my books and DVDs. Here, we use only out-of-the-money calls and select strikes based on our time value premium return goals. This is another strategy detailed in the resources I referenced in my response to Ken above.
I always encourage our members to reassess our bullish assessments on the underlying securities as I stress loyalty to our cash rather than to our stocks.
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.
New members check out the video user guide located above the recent reports.
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
Alan and the BCI team
STOCK REPAIR CALCULATOR:
Our newest calculator along with its associated user guide is now available for purchase in the BCI store. Our hope is that this new tool will assist in mitigating losses in stock-only portfolios.
Use this link:
https://thebluecollarinvestor.com/minimembership/stock-repair-calculator/
Also, we have re-organized the store page into categories to make the page more user-friendly as we have added many more educational resources the past few years.
Alan
Alan,
According to this week’s BCI Premium report, the guideline is to sell only ITM strikes and also to move 25% of the stock portfolio net worth into cash.
Question 1. Assume that I have an ETF portfolio of $15,000 which is made up of 3 ETFs i.e. $5,000 per ETF (slightly less in order to have enough funds to execute exit strategies if necessary).
By moving 25% of this into cash, the value of my portfolio will now come down to $11,250 ($15,000-$3,750). If I divide $11,250 by 3, the maximum amount I can now invest per ETF is $3,750 i.e. $37.50 per ETF. This means that it will limit my ability to buy certain ETF’s in the weekly ETF report.
Given the above, how do I rebalance my portfolio now in terms of having an adequate number of ETFs to provide sufficient diversification, especially in the current volatile market conditions?
In summary, how many ETF’s should I now have in my $11,250 portfolio and also how much should be allocated per ETF?
Question 2. Assuming that I also have a stock portfolio of $50,000 with 5 stocks ($10,000 per stock), again moving 25% of $50,000 into cash will reduce the value of my portfolio by $12,500 to $37,500.
How do I determine how many number of stocks I should now have in my $37,500 portfolio and how much per stock in order to provide adequate diversification and also to be able to buy stocks in the Weekly Premium report?
Many thanks.
Duminda
Duminda,
In our premium reports, I publish my approach to my personal portfolio each week. It is based on my personal risk-tolerance (I consider myself a conservative investor with capital preservation more important than huge returns) and overall market assessment. This approach may or may not align with that of the next investor. That’s why I also publish the assessment of the GMI and IBD as well.
Portfolios with available capital ranging between $10k and $15k will generally be populated with 2 -3 ETFs and portfolios with $35k and $50k will be populated with 5 stocks or 3 – 5 ETFs. Stocks and ETFs can be mixed into one portfolio.
To calculate the number of securities to purchase and (therefore) the number of options to sell:
1. Divide the number of securities into the total cash available. That number represents the approximate amount of cash that will be allocated to each position.
2. Divide the price-per-share into that allocated amount and round to the nearest 100. That will represent the number of shares purchased and therefore the number of contracts sold.
Example:
Portfolio worth $12,500: 3 ETFs priced at $40, $21, $25
Each position is allocated approximately $4,150.00
Number of shares purchased:
100 ($40) = $4000.00
200 ($21) = $4200.00
100 ($25) = $2500.00
Total investment = $10,700.00
Balance = $1,800.00 for potential exit strategy management and commissions
To sum up: The market summary provided in our reports is an overview of market assessment and approach from 3 different resources so members can then factor in their own assessment and then make an informed decision. It is not a “call to action”.
Alan
Alan,
Those losses you incurred in 90’s, did they came more from the capping upside or it was because the price of underlying declined sharply after the earnings report?
Sunny
Sunny,
The losses I alluded to in this article were related to disappointing earnings reports. If share price had accelerated after the report I would not have considered that a loss but rather a successful trade where my maximum return was achieved and perhaps even an opportunity to execute the mid-contract unwind exit strategy and generate a second income stream in the same month with the same cash. That said, avoiding earnings reports will put cash in our pockets in the long term.
Alan