beginners corner

Penny Pilot Program

Do you get frustrated when something doesn’t make sense? Me too. Here’s an example: You’re viewing an options chain of a great-performing stock in a great-performing industry and you note that the premiums are trading in $.05 increments. This is important information to have when playing the bid-ask spread. Then you check the same options for the following month and you see that these same strike options are now trading in $.10 increments. What’s up with that? As you scratch your head in frustration you type in a different ticker and find that these option premiums are trading in $.01 increments! These situations are not inexplicable aberrations but rather the result of the Penny Pilot Program.

Prior to 2007, most options traded with minimum price variations (MPVs) of $.05 for premiums below $3.00 and $.10 for premiums above $3.00. Beginning in January of 20007, the SEC initiated an industry wide (on six option exchanges) pilot program entitled the Penny Pilot Program, in which MPVs were reduced for certain equities. The “Pilot” reduced the MPVs to .01 for premiums below $3.00 and to .05 for premiums above $3.00. An exception to this was the ETF, QQQQ, which already traded in .01 increments.

This six-month program which started with 13 option classes (equities) has been renewed and expanded several times. Here is a list of the stocks participating in the program at the time this article was being written:

_____________________________________

Mini-SPX (XSP/XSP)
SPDR S&P 500 (SPY/SPY)
NYSE Euronext (NYX/NYX)
Apple Inc. (AAPL/AAQ)
Cisco Systems (CSCO/CYQ)
Altria Group, Inc. (MO/MO)
Financial Select Sector SPDR (XLF/XLF)
Dendreon Corp. (DNDN/UKO)
AT&T, Inc. (T/T)
Amgen Inc. (AMGN/AMQ)
Citigroup, Inc. (C/C)
Yahoo! Inc. (YHOO/YHQ)
Amazon.com Inc. (AMZN/ZQN)
Qualcomm Inc. (QCOM/QAQ)
Motorola Inc. (MOT/MOT)
General Motors (GM/GM)
Research in Motion Ltd. (RIMM/RUL)
Energy Select Sector SPDR (XLE/XLE)
Freeport-McMoRan Copper & Gold, Inc. (FCX/DPJ)
Dow Jones Industrial Average(DJX/DJX)
Diamonds Trust (DIA/DIA)
ConocoPhillips (COP/COP)
Oil Services HLDRS (OIH/OIH)
Bristol-Myers Squibb Co. (BMY/BMY)
   
Goldman Sachs Group, Inc. (GS)  
Countrywide Financial Corporation (CFC)  
Bank of America Corporation (BAC)  
iShares MSCI Emerging Mkts. Index Fund (EEM)  
Merrill Lynch & Co., Inc. (MER)  
Vale (RIO)  
EMC Corporation (EMC)  
Exxon Mobil Corporation (XOM)  
Wal-Mart Stores, Inc. (WMT)  
The Home Depot, Inc. (HD)  
Valero Energy Corporation (VLO)  
Alcoa Inc. (AA)  
Dell Inc. (DELL)  
SanDisk Corporation (SNDK)  
The Bear Stearns Companies, Inc. (BSC)  
Pfizer Inc. (PFE)  
eBay Inc. (EBAY)  
Halliburton Company (HAL)  
Lehman Brothers Holdings Inc. (LEH)  
JPMorgan Chase & Co. (JPM)  
Washington Mutual, Inc. (WM)  
Ford Motor Company (F)  
Target Corporation (TGT)  
American International Group, Inc. (AIG)  
Newmont Mining Corporation (NEM)  
Verizon Communications Inc. (VZ)  
Mini-NDX Index Options (MNX)  
Starbucks Corporation (SBUX)  

_____________________________________

These securities will trade in .01 and .05 increments while all others (except ETFs) continue to trade in .05 and .10 increments. The reason this program was initiated by the SEC was to reduce trading costs for investors by reducing the potential for market makers to earn a larger spread between option prices thereby allowing investors to trade options at better prices.

How to use this information when playing the bid-ask spread:

When the bid-ask spread is small, I simply sell at the current bid. For example, if the bid-ask is $1.35- $1.40, I will sell @ $1.35. For higher priced premiums, we move to the higher increments. So if the spread is $6.60 – $6.70, I put in $6.60 because of the tight spread. If however, there is a larger spread, we may be able to put some additional cash in our pockets. As I say in my previous writings and seminars, we don’t want to insult the market makers but rather we want to be “mild pests”. Let’s say the spread is $1.10 – $1.40. I compute the mid-way point which in this case is $1.25. Then I will place a figure slightly below that point. If we are trading in .05 increments that figure will be $1.20. No insult to the market maker, and he very well may pay us just to get rid of us. That’s $10 per contract in our pockets, perhaps a few hundred per month, a few thousand per year and tens of thousands over an investment lifetime. If the options are part of the pilot program, the limit order can be placed between $1.20 and $1.24. I like to look at returns in terms of percentages rather than dollar amounts (see the chapter on calculations in Cashing in on Covered Calls to review my calculation equations). By understanding the Penny Pilot Program and playing the bid-ask spread, if we generate $1.20 per contract rather than $1.10, we have increased our returns by 9% (10/110)!

Conclusion:

The Penny Pilot Program is another tool Blue Collar Investors can use to level the playing field with Wall Street Insiders. I know that there are those who will pooh-pooh the small amount each trade will improve by, but I’ll bet these same folks are cutting $0.50 coupons out of the newspaper to get a “great deal” on a bar of soap. That extra cash will go either in our pockets or those of the market makers. It’s a no-brainer. Understanding the Penny Pilot Program and knowing how to play the bid-ask spread will make us significant profits over the long run.

Where’s Alan?:

I’ll be out of the country the first week of November with limited access to my computer. I have prepared journal articles for both weekends which will be published at their regular times. For premium members, the weekly report will be published at their regular times. The ETF report next week may be slightly delayed and in abbreviated format. All books will be shipped within 1-2 business days of the order. DVDs and CDs ordered after October 28th will be shipped on November 8th. I will do my best to check in from time to time and should catch up with the emails during the second week of November.

Market tone:

On November 3rd Fed Chairman Bernanke is expected to announce a second round of quantitative easing by buying Treasuries which would decrease bond yields, devalue the dollar and enhance the value of stocks. As many investors are holding their collective breaths that this will occur, I am not as excited about such an event. I feel that this move by the Fed is already priced into the market and could only hurt stock prices if it does not come to fruition. I am focused on the S&P 500 chart formation, the level of the VIX, economic reports and earnings results. So far, so good on these fronts. For the week, the S&P 500 remained unchanged for a year-to-date return of 7.8% (including dividends).

Summary:

IBD: Market in a confirmed uptrend (as of Thursday October 28th)

BCI: Moderately bullish selling more O-T-M strikes

Wishing you the best in investing,

Alan (alan@thebluecollarinvestor.com)

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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.

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64 Responses to “Penny Pilot Program”

  1. admin October 29, 2010 6:48 pm #

    BBD:

    Last week this stock failed the BCI screening process. Before I head off to the airport I thought I’d construct a chart to explain. Note the following on the chart below:

    – The price drops below the 20-d ema (red circle).

    – There is a negative MACD divergence (blue arrow).

    – We see a bearish stochastic signal (green circle).

    This explains why the stock moved to a “pink field” on the premium report.

    Alan

  2. Don_B October 29, 2010 7:22 pm #

    Great article about the penny pilot program. Cannot help but wonder why on the option chain page there could not be printed, for each stock, or option, the actual increments?? All they (CBOE?) would need to do would be to print a code, such as “.01 to 3.”, and/or “.05 above $3.”

    FWIW.

    Don B.

  3. Dirk October 30, 2010 7:52 pm #

    Thanks for the good article Alan,
    have a nice flight and come back in one piece.
    We need you here. :>)

    And watch out for the cargo they put in your plane.
    If there have hanging out red wires of some sort. . .
    :>)

    Cheers
    Dirk

  4. Doug October 31, 2010 3:47 pm #

    Alan, Great info and service as always. Off-topic, is there any way you could get the premium stock screens out Friday night or Saturday morning? Instead of late Sunday night? Would be nice to be able to do the analysis and selections before Monday morning. Thanks.

  5. DaveD October 31, 2010 4:38 pm #

    MED:

    The chart shows a bullish engulfing patten. In addition to this the stochastics and RSI are oversold. The ER comes out in the nest few days…

    JCG: This stock also shows a bullish engulfing pattern. The stochastics are also oversold.

  6. Barry B October 31, 2010 4:53 pm #

    Doug (#4),

    I prepare the Premium Report and I is not possible to get the report out when you ask. There are a number of reasons:
    [1] The data is not available in a timely fashion from our sources. One of the sources is inconsistent as to when they publish the data…can vary by 2 – 3 hours on Friday night.
    [2] Due to the nature of the combination of the data sources that we use, there is no practical way to automate the import of the data. If we did import the data, the price would rise significantly due to the subscriptions involved.
    [3] So…much of the data is gathered manually…entered…and checked multiple times. Typically there are over 1200-1500 data items that are processed each week.
    [4] Each chart for each of the stocks (both in the weekly screen and running list) is individually read and commented on.
    [5] Every stock on the running list is rescreened every week to give you accurate data for the stock during the month.
    [6] After the analysis is done, then then “red” stocks are backward reviewed each week to determine if they need to be removed from the running list.

    Our commitment has been to get the data out before the opening of the market the following week. We have met this target every week…most weeks getting the report out on Sunday…usually before 9 PM.

    I hope you are getting a sense of the amount of work that goes into every report. We are constantly improving the report to make it an invaluable tool to use with the BCI System. For the most part, we have found a way to incorporate subscriber requests…considering that each request adds time to prepare… while not increasing the cost.

    Sorry for the rambling response, but a ton of effort goes into the report every week and there is no way we can get it out earlier without a significant increase in our costs.

    Best,

    Barry

  7. Barry B October 31, 2010 4:57 pm #

    The Premium Report has been uploaded to the Premium site at 4:55 PM.

  8. Doug October 31, 2010 5:22 pm #

    OK Barry. Thanks. Just thought I’d ask.

  9. Barry B October 31, 2010 5:39 pm #

    Doug,

    No problem. This question comes up from time to time and I took the opportunity to try to explain the process. In addition to the raw data handling, there are numerous intermediate sorts to get the data organized to better coordinate the data between the Weekly Screen ans the Running list.

    I hope I gave you a sense of the effort involved. Thanks for understanding.

    Barry

  10. Don_B November 1, 2010 12:53 am #

    For Dave D –

    I wonder just what a bullish engulfing pattern (your #5) is?? TIA.

    Don B.

  11. Dirk November 1, 2010 12:44 pm #

    Maybe DaveD is looking at the intraday chart.
    That looks like the 20 EMA is crossing the 100 EMA upwards. MACD is slightly up. Stochastics are just at 50 and the Chaikin moneyflow is on the positive side.
    But when you go to a 6 month or 1 year chart, it looks all bleak and more selling than buying since october 14.

    Cheers
    Dirk

  12. Kathy November 1, 2010 2:43 pm #

    I am new to this system. I bought BIDU and sold a CC when it was in the PASSES ALL SCREENS list. Should I buy back the CC and sell the stock or wait until expiration date?

  13. Kathy November 1, 2010 3:25 pm #

    Please ignore my previous message. I just realized that the stock you were discussing was BBD not BIDU!

  14. DaveD November 2, 2010 2:53 am #

    Hi Don

    You asked about the ‘bullish engulfing pattern’.

    A bullish engulfing pattern is comprised of a large white real body that engulfs a smaller black real body in a downtrend.

    A perfect example in a chart of MED is the 6th and 7th of July 2010. You can see the body of the candlestick on the 7th completely consumed the body of the bearish candlestick on the 6th of July. This happened after a downtrend. And look what happened afterwards in MED.

    These areas can often become support for the stock and can also sigify an uptrend.

    Hope all is well Don

    Dave

  15. owen November 2, 2010 10:26 am #

    Sometimes it amazes me how every mutual fund is required to state, in LARGE BOLD letters “Past performance is no guarantee of future results” and, yet, everyone goes forward trying to use past performance to determine future results.

    Motorola was a great investment until Nokia showed them how to make the next generation of phones. Vivus was a good investment until the FDA stomped on its weight loss drug. Three years ago yesterday you could have bought CROX for $75. Two years ago yesterday you could have bought it for $2.51. By yesterday it made it all the way back to $14. Yippee. No it didn’t split.

    We use Alan’s criteria for choosing the best of the best….today. The reason we sell the nearest call option is because the stock may not be the best of the best next month. The charts are useful for showing current trends. If you put too much reliance in the graph patterns, you may well find your head and shoulders pattern under the crashing surf pattern, or the up in smoke pattern.

  16. admin November 2, 2010 11:30 am #

    To the BCI community,

    Linda and I are enjoying a wonderful cruise to the Mexican Riviera and thinking of you. I have limited email access but see a huge backlog of emails you sent and will catch up next week. Many thanks to Barry and Owen for helping out.

    I have an interesting blog article that I wrote before leaving for this trip which will be published at the normal time this weekend.

    Once again thanks for all your support and well-wishes.

    Alan and Linda

  17. Dirk November 2, 2010 12:29 pm #

    @ anyone
    I bought shares of the same stock at different prices into the same account. How can I write different calls on the specific stocks?
    More clearly, I would like to write some calls ITM for a specific batch I bought and some calls OTM for a specific batch.
    Maybe somebody had this problem already and knows the solution. . .

    Cheers
    Dirk

  18. owen November 2, 2010 12:56 pm #

    Call the broker and ask them how to specify the tax lot being called, if it gets called.

  19. Dirk November 2, 2010 2:35 pm #

    Thanks Owen!
    In the meantime I went into my brokerage account and found under the “Positions” tab a button named “lot” on each position line.
    It was hidden up to now, because the specific window was bigger than my program screen.

    Now I am able so see the different lots I bought.
    I can see even the different lots in one trade when the order gets filled in partial fills over the course of a few seconds.
    Cool!
    Like Owen mentioned, it is now up to me to talk to my broker to figure out which of those lots is getting called, or which I want to have called, if so required.

    Cheers
    Dirk

  20. owen November 2, 2010 2:53 pm #

    Dirk,

    The reason asking is important is because the call exercise is done by computer. If you were to call the broker, and tell them to sell the lot from 10/28/10, that is specific, and you made the lot identification. If the computer is allowed to do its own thing, it may use FIFO (first in, first out), or it may use LIFO (last in, first out). You need to know which.

    Remember, this really only matters if you are still holding some of the stock over the year end. If 100 shares get called on Nov 20, and you sell another call for Dec 20, which gets called, all of your gain will be in the current year, anyway. And the odds of you having more than a $2 or $3 difference in price in the tax lots is very slim, unless you are holding the stock through earnings reports. Where this would matter is if you bought 500 shares of a stock four years ago and another 500 this year for a $15 price difference.

  21. Dirk November 2, 2010 3:23 pm #

    Another stupid one :>)
    when I use the buy/write feature, the net debit appears also in the bid-ask format.
    Since I am buying a stock and selling a call, which one is the one I am looking at?
    Slightly confused! :>)

    Cheers
    Dirk

  22. Dirk November 2, 2010 3:26 pm #

    Oh, I didn’t see your answer Owen, before I pressed the submit button for my #21
    Thanks!

    Cheers
    Dirk

  23. DaveD November 2, 2010 4:32 pm #

    A note on the bullish engulfing pattern discussed in post #14.

    If you look at the bottom of an uptrend, you will often see a bullish engulfing pattern.

    Example 1 : (GMCR) The 11th and 12th of October.

    Example 2: (GMCR) The 30th and 31st of August

    Example 3: (EJ) The 11th and 12th of August

    These are a symbol that the bulls have taken over the market.

    So what about a posible sign that the bears have taken over? Is this possible to have a sign of this before the stock drops… YES…

    This is known as the ‘bearish engulfing pattern’.

    A bearish engulfing pattern occurs when selling preasure overwhelms buying force as reflected by a long black candlestick body engulfing a smaller white candlestick body in an uptrend.

    Example 1: (GMCR) 21st and 22nd of september.

    Example 2: (STEC) 3rd and 4th of August.

    Example 3: (SPX) 29th and 30th of April

  24. DaveD November 2, 2010 4:35 pm #

    To properly view the above examples on a chart, you will have to view from a candlestick chart and NOT a bar chart. This can easily be done by selecting candlestick on the scroll down…

  25. Don_B November 2, 2010 6:54 pm #

    To Dirk – your #21 –

    Not a stupid question at all. IMHO, it does not really, matter, I think , which is which though. You are doing both, really, and are coming up with a NET debit. You can place a limit order, specifying how much you are willing to sit tight for. I have noticed that sometimes I get filled where the bought stock itself goes up by a few cents, but so does the sold option. That is why it is net. In a sense this fact does allow you to play the spread, and since you are unable to know if it will bend your way while you await fill, you specify the debit – a limit order in a way. Hope I am clear here. Good luck.

    Don B

  26. DaveD November 2, 2010 11:54 pm #

    OWEN, While I do agree with you 100% that Alans criteria selects the best of the best of todays stock available, I have a question over weather these stocks are more at risk of coming back to a support level. Is it possible these stocks are at resistance levels and they will come back to support?

    Owen, I look foward to your response as you always have something wise to share…

    Dave

  27. Rob K November 3, 2010 9:44 am #

    Alan,

    I have a request for the member reports. Could you add the number of weeks a stock has been on the list beside its name in the “Passed Screens” and “Mixed Data” area? It would be nice to see that informati0n without having to scroll down and find it and then scroll back up

    Rob

  28. Dirk November 3, 2010 10:10 am #

    Now it happened!
    Early assignment!

    I had bought IGTE on Oct. 19 for $ 18.46 and sold the Nov $17.5 strike the next day ITM for $1.80
    Yesterday IGTE closed at $20.35 and at the opening at 9:30 this morning, my Fidelity Active Trader Pro program was alarming me with a door bell alarm and showed a message, that my IGTE stock has been assigned.
    At first I thought, that was a mistake, because Nov. 20 is still far away, but then it hit me.
    Geez, that was an early assignment!

    But they only assigned 200 out of 500 shares.
    So the other 300 are still sitting happily in my account. :>)

    Cheers
    Dirk

  29. owen November 3, 2010 11:10 am #

    Dave D… When will a stock will start to fall after a recent runup? Nobody knows. Certainly, the higher it climbs, the more likely it is due for a correction of some sort. Some of the charts are useful INDICATORS that something may be coming up. I would consider them like checking off a checklist of things to look for that often, but not always, mean that the stock is due for a fall, rise, whatever.

    Such a checklist might include:
    Stochastic movement, volume changes, news reports, talking heads speculation about upcoming earnings or products, short stock percentages, government regulation changes, discussions on the BCI board, open options positions, options volume, etc.

    I know this sounds a bit much, but you’re protecting your money from raiders. It’s not like you have to run through the list for every stock on the NYSE. The more confident you are about your position, the less you probably need to go through every item on your checklist.

    Dirk…. You probably got hit by a short seller closing his position. The short interest on IGTE is only 3.6% today, but I don’t know what it was a week or two ago. That is a figure that you might want to look up when you add a stock to your watch list, just so you know what the change has bee since you last looked at it.

    When someone exercises an option early, the computer system randomly selects from the open positions in the broker world, and yours got hit. If your strategy was to have the stock called away, well, congratulations, you don’t have to wait until November 20 to get your money back. Send the soldiers out to do it again. Go for a double.

  30. Barry B November 3, 2010 3:32 pm #

    When you get early assignment…you’re OK. My goal is to be called out of my positions each month. That means that I hit my personal targets/goals for the option month and the system is working.

    Barry

  31. Don_B November 3, 2010 5:52 pm #

    Hello Dirk – #27 –

    Looks to me like you made 4.55% on your investment between Oct. 19 and Nov. 2. (1.80 minus the 96 cents diff in the money is .84/18.46). At least on those 200 shares. Can’t knock that 2 week period gain with a wooden stick, right?

    Presuming that it stays above the 17.50, you will do the same percentage, but for a longer term. Still wonderful. Great work!

    Don B.

  32. Don_B November 3, 2010 6:04 pm #

    Barry – your #29 –

    My goal, likewise, has always been to be called out each time. Either that, or to be as close as it can be to be out of the money, so that I can write again.

    One time I had the experience of having the closing price land smack dab to the penny onto the strike price and I did not get called out! How cool is that?

    FWIW.

    Don B.

  33. Dirk November 3, 2010 8:45 pm #

    @ Owen and Don_B
    yeah, it was a good deal and still more to come.
    I used the money from the early assignment to buy 35 more shares of MSB, which was a little bit down in the middle of the day.
    I was able to get it for $38.76 and together with the 65 shares I owned (for $37.48) I could sell one Nov 40 contract for $1.35/share.

    So, the second set of soldiers is out in the battle for the same month.

    The combined stock price I paid was $38.16
    At exercise I will have made 3.3% figuring in the commissions. Not bad.
    If assigned, I’ll make an additional $184.
    Not bad at all.

    We are so lucky, that we have the BCI system in place, which prescreens the stocks for us.
    Together with Alan’s books, the premium member toys and the support here in the blog we can really beat a lot of the so called “financial advisors” out there.

    I am just at the beginning, but have, after the first month’s roller coaster, already some good results.
    I was trying another “system” for a while, but the results have been 55/45 at best, whereas here in the BCI family it looks more than 90/10
    (The first numbers are always the winners :>))

    Cheers
    Dirk

  34. DaveD November 3, 2010 11:31 pm #

    Chart of the S&P500

    From what we can see from the S&P500 there are a few conclusions thus far…

    1) We are currently in an uptrend resulting from an inverted head and shoulders pattern…

    2) Resistance (from the april 2010 high and the inverted head and shoulders proposed uptrend resistance) stands at about 1217 points…

    c) Are we going to see a break past this resistance or are we going to see the bears take over for a while? Obviously we cant predict the market, but we can certainly get an EARLY warning signal from any recognisable candlestick patterns.

    d) I will personally be on the look out for bearish candlestick patterns such as the one mentoned earlier (Bearish engulfing pattern). If I see any I will be sure to post them here in the forum.

    Best of luck to all

    Dave

  35. Dirk November 4, 2010 8:11 am #

    @ DaveD
    How did you set up your chart for having a good recognition of the Bearish engulfing pattern?
    Which day and time interval?

    Cheers
    Dirk

  36. Dirk November 4, 2010 8:58 am #

    @ Don_B
    back to the buy/write with a net/debit price.

    I can change the net/debit price by hand in my system, but still don’t know, in which direction.

    In a normal bid/ask situation, where we play the bid/ask game when selling a call, we would put our price limit a little bit closer to the bid price, in order to have a chance to get filled.

    But in case of he net/debit price I would like to know where the chances to get filled are bigger.

    Cheers
    Dirk

  37. Dirk November 4, 2010 9:51 am #

    @ all
    What makes out the bid/ask spread?
    Just have a look at the attached option chain of IGTE.
    The spreads are huge.
    Is it because of non existing call volume?
    Is it just a try of the market maker and it will change once there are bids and asks for a particular call?

    Cheers
    Dirk

  38. owen November 4, 2010 10:12 am #

    The bid/ask differences are pretty much a combination of supply and demand (read because they can) and the price of the options. The higher the option premiums, the higher the spread people are willing to tolerate. The higher the demand for the options the higher the spreads may run.

  39. Dirk November 4, 2010 10:19 am #

    @ Don_B
    When you have a look ate the attached Multi-Leg option window, you see at the bottom the system generated Net bid/ask.
    It assumes buying the stock at the ask (bold at he bottom) and selling the call at the bid.
    In the order details (upper right) I can change the amount I am willing to pay.
    In the meantime, playing around with it, I assume that I only have to look at the Net bid/ask (bold ate the bottom) and keep my bid closer to the lower price in order to have a chance to get filled.

    Cheers
    Dirk

  40. owen November 4, 2010 10:22 am #

    Dirk (your #35)

    If you set a net debit price you are insisting that the stock and option prices move to a combined point that will give you that price. If just one of them is off a bit, the net debit will not be reached and the trade will not go through.

    The biggest problem I have with setting the net debit is that most of the stock and option prices are on 15 minute delay. You may be chasing a ghost all day. I usually use market price and accept that I may be throwing away 4 cents a share, but I am making $3.75. I’ll live.

  41. Dirk November 4, 2010 11:14 am #

    I can’t afford to loose 4 cents on profit, Owen.:>)
    I am greedy!

    In my above example the net bid/ask spread is between $19.54 and $20.15
    I think, if I stay with my bid at around $19.90 or higher, I have a chance to get filled and make some additional Pennies to pay my lunch

  42. owen November 4, 2010 11:32 am #

    In the above example, if you accept the $0.25 difference you get the deal now and, potentially, have a trade set to earn $275, 3.2% for the month (example). If it doesn’t go through you saved a $25 added cost, and gave up the $275 potential gain, leaving the soldiers sitting on their butts in the trench.

  43. DaveD November 4, 2010 11:59 am #

    Hi Dirk

    In post #33 I was referring to a 1 year chart set to daily candlesticks…

    To best view bullish/ bearing engulfing patterns you might look to see the last 3 months or last 6 months on a chart… Once again this would be a daily candlestick chart…

    Dave

  44. Don_B November 4, 2010 1:08 pm #

    For DIRK #38 –

    I do think I agree with Owen’s comments on the Buy/Write – sometimes give up a few cents to snare a winner, in effect. Since I believe you said you use Fidelity, you can even phone their 800 no. to discuss these issues – they are extremely helpful and are not difficult to connect with either.

    But in the buy/write situation since we are dealing with bringing two elements together I think the things you describe are just “the nature of the beast”.

    Good hunting, sir.

    Don B

  45. Don_B November 4, 2010 1:19 pm #

    Alan & All –

    This morning, the gold & silver markets rose quite well – I noticed the silver was up over $1. Wow. Also noticed that GDX had a nice move.

    We had in place two contracts of GDX with a s.p. of $55 Nov. So what did I do? I did a BTC on them at 4.70. This resulted in a big fat loss on the option itself but a dramatic gain on how much of the stock uptick I get to keep! After doing that I immediately STO both contracts ITM at 59, but for tomorrow’s expiration, the weekly! This resulted in the original gain on the stock (presuming assignment in either case) being identical. In actuality, I moved the net profit to the day after tomorrow from 11/20 – -again, I must assume callaway. And all this from just a few keystrokes on the computer.

    THANX ALAN !!!

    Don B.

  46. Don_B November 4, 2010 1:31 pm #

    PS – – and who would have thought of the endless possibilities that present themselves due to the introduction of the weekly options? In my #44 above, I went from the monthly Nov. to the weekly closing Saturday 5th, but could just as easily have gone to the weekly that expires on Sat. 13th, which were displayed starting today. Flexibility indeed!

    Our blog, I note, is becoming more interesting by the day!

    Don B

  47. owen November 4, 2010 2:31 pm #

    I thought I would update everyone on my Apple put spread. On Friday, 10/14, correctly believing that Apple would report blowout earnings on 10/17, I sold the Apple 300 PUT option for $11.66 and bought the Apple 290 put for $7.66. I collected a net $400. At the time Apple was trading at $302.

    Today, Apple is trading at $318. The Nov 300 put has fallen to $1.34, a profit of $1,032. The Nov 290 put has fallen to $0.62, a loss of $704. If I let it run, which I am doing, I will end up with $400, net. If I want to get out now, I can keep $328. Not bad, on a $1,000 investment for three weeks.

    Up, down or sideways, carefully selected options allow you to make money no matter which way the stock market moves.

  48. owen November 4, 2010 2:34 pm #

    Quick note: I only risked $1,000 on this trade. Yes, if I had risked $10,000, I could have made $4,000 in a month. I also could have LOST $10,000 in a month, too. I may give that a try when $10,000 has the same importance to me that $1,000 has today, but not before.

  49. Dirk November 4, 2010 5:03 pm #

    Thanks, DaveD

    Cheers
    Dirk

  50. Don_B November 4, 2010 5:03 pm #

    For Owen – # 46 & 47 –

    I am trying to clarify that spread situation in my mind. If Apple falls to 300 you get “put to”, causing you to invest $30,000. (100 shares). But if it goes to $290, you still of course have to pay out the 30 k for your 300 put, but then you would have ownership of that 290. Here’s where I lose it – how do you use that 290 to protect you? And does it merely protect you from further loss at any level? I have seen graphs on these but they are no help to me.

    And on another angle, if you had only sold the 300 and not bought the lower one, you can only lose the 30,000 if the company goes out of business. Yes? If the stock dropped at expiration to, say, 280, you would lose $2000?? (100 shares x $20.)

    TIA.

    Don B.

  51. owen November 4, 2010 7:00 pm #

    Don,

    Ok, here’s how the Apple put spread plays out. First, remember that what I bought is a $290 PUT, not a $290 CALL. I can make someone BUY the stock from me for $290 per share.

    If the stock stays at, or above, $300, both options expire worthless. I net $400 profit.

    If the stock settles between $300 and $296, I get put the stock at $30,000, turn around and sell it for market, and make $400, less the difference between the $30,000 and the proceeds from my sale. Let’s say the price is $297. I will keep the $400 spread on the put premiums and lose $300 selling the stock I had to buy.

    Last choice is the stock tanks to $250. I am forced to buy at $300 and I turn around and use my $290 put to make the next guy buy the stock for $290. I lose the full $1,000 (partly offset by the $00 option premiums) difference between the $30,000 purchase and the $29,000 sale. I can’t lose more than $1,000 even if the stock drops to $1.38.

    So, in reality, my entire risk on this trade was a grand total of …… drum roll, please …….. $600 out of my pocket. I received $400 net debit when I opened the positions. The most I could get hit for was $1,000. Those funds were “frozen” by Schwab to protect themselves in case my trade went against me, but $400 of the $1,000 they “froze” was the other guy’s money he paid me. Is this a great country, or what?

    This actually turns out to be a better percentage return than just selling the $300 put option. Schwab would have frozen $30,000. I would have gotten $1,166 for putting up $30,000 in cash for a month. That’s a 38.9% return. Getting a net $400, for putting up $1,000 for a month, is a 40% return.

    Yes, you are correct about the naked short. If I had only sold the $300 put, and the stock went to $280, I would be out $2,000, if I immediately sold it at $280. The $290 put protects me from that happening.
    Is this a great country, or what?

  52. Dirk November 4, 2010 9:28 pm #

    Huuhh Owen, I have to digest this one for a while and play with it.
    All in all it looks like spreads make more money than just covered calls and put-spreads even more.

    But I still have this kind of upside-down/reverse/not-fully-comprehend feeling when I think about puts and especially writing/selling puts.
    The “Put Option Writing Demystified” book is sitting already on my desk and awaiting my markers, pencil comments and sticky notes, but one at a time.
    I am still fighting with myself to decide on which call options to sell and at which strike price.

    Delta, Implied volatility, Theta and Vega, volume, stochastic, MACD and Chaikin demanding my attention and I am also working on a script or flow chart how to evaluate a stock, what option to sell, when to buy back etc.etc.

    Essentially I like to have a very, very condensed version of Alan’s 2 books.
    We’ll see what comes out at one day.

    Cheers
    Dirk

  53. Don B November 4, 2010 9:44 pm #

    Dirk –

    The part about Put Writing that it seems to me to be best is that one can actually acquire a stock cheaper than market! Takes attitude, tho. If you feel that “Gosh, I would like to acquire that stock cheaper than market but I will not choke if I do not get it”, then this is plausible. (And make income in that case!). I have written those naked puts, but one must have a strong bullish feeling before doing them.

    Just a thought or two.

    Don B.

  54. Don B November 4, 2010 9:45 pm #

    Owen – Thanx much for the detailed explanation, which clarifies a lot. I have printed my post and your answer for my keeper book. Thanx again.

    Don B.

  55. owen November 5, 2010 10:40 am #

    Everyone, the discussion about spreads should be set aside until you are completely comfortable with covered call writing.

    Okay, Don, Dirk and a few others, spreads are cheap ways of entering a PROTECTED position. Let’s look at the reasoning behind the “protect” side of each trade. Lets use XYZ stock at $38.

    Covered call: I want to sell the XYZ $40 call and collect the $2.75 option premium. Fine, but if I sell it, and XYZ goes to $100, I can lose $60. So, I buy the stock at $38. Now, the only real reason I bought the stock is “just in case” XYZ goes to $100. Okay, I may get an extra $2 on the upside, but I may not. Still, the only real reason I bought the stock was to “protect” me from a huge price rise in the stock and having someone call me and say “gimme your stock”.

    Let’s look a call spread. I think XYZ is going to rise. I want to sell the same $40 call for $2.75. I don’t want to put up $3,800 for XYZ, but I am willing to buy the XYZ $20 call for $18.50. How is another option “protection”? Because, if XYZ goes to $100 I simply call in my XYZ for $20 and turn around and sell it to the $40 call buyer. My cost for the stock will be $3,850 ($20 strike + $18.50 premium), instead of the $3,800 I would have spent four weeks ago. So, if Sue’s (she bought the stock at $38 and sold the $40 call) covered call gets exercised she gets the $2.75 premium + the $2 upside. You bought the stock on the expiration date and spent $38.50, but you got the same $2.75 + $2. Why is this a possible choice in your trading strategy? Do you want to sell a GOOG covered call? Do you have $62,200 to buy 100 shares? Didn’t think so.

    So, what a spread does for you is give you some other trading strategies that can fit a particular need for what you think the market will do. If I think the stock may rise, I can buy the lower call and sell the higher call, in the hope that the stock gets called away.

    If I thought the stock might drop, I can buy the $45 call (let’s say it’s $0.82), and sell the $40 call at $2.75. I will hope that the stock stays under $40, or drops to $2, I don’t care.

    Now, the call premiums might make a bullish attitude a bit expensive. So, what I did with Apple was use the large time premiums to my advantage. The stock was $302 when I sold the $300 put. That gave someone the right to make me buy their stock at $300. They aren’t going to do that if the stock stays above $300, or $310, or $875.63. Now, just in case the stock dropped, and I didn’t really want to own it at $300, I “protected” myself by going out and buying the right to make some other poor fool buy my Apple stock for $290. I believed the stock was going to go up after the earnings report. Got it?

    Okay, suppose I think Apple will drop after the earnings report. I BUY the $300 put for $11.66, and SELL the $290 put for $7.66. How does that work? Well, let’s work through the permutations on a piece of paper:

    Apple stays above $300. I lose the $11.66 for the $300 put I bought, but I keep the $7.66 for the $290 put I sold. I am only out $400.

    Apple drops to $297. I buy Apple for $297 and sell it to the put seller for $300. I make $3.00 on the exercise, I lose the $11.66 I paid for the $300 put, but I keep the $7.66 for the $290 put I sold. I lose a net $100.

    Apple drops to $150. The guy who bought the $290 put from me sends me his stock for $290. I turn around and send it to the guy who sold me the $300 put. I make $600 net ($10 for the stock spread -$11.66 I paid for the $300 put + $7.66 I got for the $290 put I sold).

    Yes, spreads are a bit complicated, but they can be broken down into pieces.

    I want to make money by selling this call. How do I protect myself from an unlimited loss? I can buy the stock, or I can buy a different call that can limit my loss, if I exercise it.

    I want to make money by selling this put. How do I protect myself in case there is a very large drop in the stock price? I can buy another put to give me the ability to make somebody else share the pain.

    Work through the details. Feel free to contact me at osargentcpa@aol.com if you have another specific question. I think we have taken up a bunch of space discussing something that many of you should avoid, at least for the near future.

  56. Don B November 5, 2010 1:06 pm #

    Owen – your #54 –

    Until now I never really thought of doing a CC as a spread – but I do now!

    I note that your para 3 on CC starts with it being a naked option.

    Anyway, your work is so finely detailed as to be SO worthwhile. I am printing it as a keeper, again.

    Your caution on doing spreads is noteworthy. I have done a few naked puts (cash covered, of course), but in this kind of market atmosphere presently they are probably not a good idea. Further, to write any option to gain, say, 3% and then reduce it to make the final result, say, 2% is really not worth the trouble – to me at least. Why not simply do the covered call (which is a spread, as above) for that same 3%. In that one, the risk is the stock itself, as Alan has repeatedly said.

    Thanx much for your fine efforts.

    Don B.

  57. owen November 5, 2010 3:23 pm #

    Don,

    You shouldn’t just focus on the 3% vs 2% return, at the expense of reducing risk. If I can enter 5 trades, and make 2%, or enter 1 trade, and make 3%, I am probably going to do the 5 trades. I am spreading my risk to a few different stocks, instead of concentrating it in one stock. Remember the Wall Street credo, “Bulls stampede, bears roar and pigs get slaughtered.”

    As for the covered call where you buy the stock, again, sometimes it depends on the amount of funds you want to commit to the trade. If I can put on a spread on Google that will earn me a decent return, but only requires that I put up $3,500 to enter the spread, isn’t that better than paying $62,200 to buy the stock, just so I can sell a covered call?

    If you’re dealing with a $35, or $45, stock, buying the stock isn’t that bad. If you want to sell a call on a $300 or $600 stock, you’re starting to get into the high rent territory. Again, the same BCI rules should apply to the underlying security. Don’t put on a spread where you wouldn’t do a regular covered call. One leg of a spread is basically acting as a substitute for buying the stock outright, at this moment. You may wind up buying the stock and immediately selling it on expiration Friday, but the debit and credit will be netted on that day.

    Look at my Apple trade. I put up $1,000 to enter my spread. If I had just sold the $300 put, I would have had to put up $30,000 for a month. At $1,000 per position, I can use the $30,000 to spread my risk to 30 stocks, if I can find enough that meet the BCI requirements.

    Spreads are just another way to make money in the stock market. You are basically creating something out of nothing. You don’t own the stock. You didn’t borrow the stock and sell it short. You are just entering into two binding agreements that you MAY have to fulfill, but may not have to. For that, someone wants to give you money. Well, alright, if you absolutely INSIST, I will take your money.

  58. Don B November 5, 2010 9:16 pm #

    Owen –

    Okay, I was not really focusing on the 2% or 3%. I was just trying to compare the effort and thought involved in the spread technique to simply doing the CC procedure. Yes, even when entering a covered call, buying a cheap Put alongside it can be quite protective.

    So far I have never done so – once or twice to my regret. Overall, tho, my CC program has been quite successful. I noticed that even when taking a shellacking a couple of times it is, over the year, just part of doing business. The stock risk, of course.

    Your thoughts are powerfully accepted, tho, as you make excellent points. Again, printed for my records.

    Thanx once again.

    Don B

  59. Barry B November 5, 2010 11:24 pm #

    Team BCI,

    I’ve been watching the various posts discussing option spread strategies. I love spreads, especially credit spreads. However, there is a lot more that you MUST know and understand before you get started in these types of trades.

    Thew way I trade, aside from doing ALL of your homework relative to the market and stock fundamentals, is a through understanding of chart patterns and technical analysis. Per some of Owen’s examples, i.e.: the Bull Put Spread, you must know where strong support is…making sure that the stock is in an uptrend…and placing the trade under that support. Having that knowledge of where to place the trade relative to support allows you to sleep at night. Of course, support and uptrend must be verified by the appropriate technical indicators, so in effect, you have a confluence of fundamentals, chart patterns, and indicators.

    Similarly, with a Bear Call credit spread, you need to understand where resistance is, and a confluence of chart patterns and indicators that allow you to place the spread above resistance for a stock that is in a down trend.

    While it appears that spreads in general and credit spreads in particular are wonderful trades, YOU BETTER KNOW WHAT YOU ARE DOING. In addition to understanding all of what I mention above, you also need to know how to adjust your trade in case the trade does not meet your original hypothesis.

    This is why Alan has focused his attention and efforts over the years on covered calls. They are trades that you can understand and manage. While these more advanced trades are appealing, they can blow up on you very quickly. If you have any thoughts on learning these advanced spread trades, be prepared to invest hundreds…yes hundreds or more…hours in learning the methodologies.

    Now…if you do, in fact, make the decision to learn these advanced techniques, I would suggest the following:
    – learn the collar trade (as discussed in the past)
    – learn the bull put trade

    In addition to the covered call, knowing these two additional trades will give you a good set of tools for most market conditions. You could initiate your trade with a bull put. If you get put the stock, you can adjust the trade into a covered call or collar. Then manage the covered call or collar back to cash and start again.

    I know that this post is really out of scope for this forum, but I wanted to state to fellow BCI’ers that the covered call is a wonderful trade and for most of us, it is all we need. You might want to add the collar (covered call with a protective put)…but I would keep it there. These other techniques really take a lot of training to understand. And if you are not in front of your screen most of the day, they can be quite costly.

    Just my 2 cents. I apologize for rambling…

  60. DaveD November 6, 2010 5:00 am #

    Owen, congratulations on your Bull Put Spread trade… Nice one!

    Here are a few questions I have for you regarding this style of trading…

    1) You made 60% on this trade. Now with covered calls we are making 2-4% a month (give or take). Why dont you just do spreads? What are your reasons?

    2) Owen, what do you think is a reasonable expectation to make in covered calls on an annualised basis?

    3) Are there market conditions or times when you would just put the covered calls aside and just do a spread in order to make a truck load of ca$h?

    Note: There is a website called http://www.planetwealth.com.au … They have a results page which compares a variety of their trading accounts. (2 of which are selling covered calls in the US, and credit spreads in the Australian market.)

    The results for US covered calls are 36.5% for the last 2 yeasrs. The results for spreads is 16.1% for similar time frame. Although, from 2005-2008 they claim to have made nearly $500,000 in profit doing spreads. The average return on each trade was over 12%, losses included… Now I know you cant live of that, but isnt that a good start!

  61. DaveD November 6, 2010 5:01 am #

    Owen, I meant to say 40%, not 60% at the start of my last post…

  62. Saul Seinberg November 6, 2010 5:04 am #

    DavidD re your #23.

    One of the recurring questions received when a specific candlestick or point and figure pattern is discussed asks how do I find these patterns? Clearly, all of us want to avoid the task of reviewing hundreds if not more charts each day or week.

    I use and rely on point and figure charting. There are certain compelling patterns that I like to trade, one of which I rely on for option trading. A couple of years ago I discovered an easy way to significantly cut down on the time demands of pattern investigation. This short cut also applies to candlestick patterns.

    Go to http://stockcharts.com/def/servlet/SC.scan. There you will find three tables that respectively show how many stocks are exhibiting various important technical indicators, candlestick and point and figure patterns.

    In this morning’s candlestick table, for example, there are 12 NASDAQ stocks with charts showing a bullish engulfing pattern, the topic pattern of several comment notes in this blog.

    Click on the number “12” and you will then see a table with all 12 stocks listed. A chart for each individual stock, there are 4 possibilities in the left-hand column, showing the predefined pattern of interest can then pulled up via easy click-thru access.

    I use this predefined signal pattern scanning capability to find stock’s of interest to me. I’ve relied on this capability for both candlestick and PnF charts with excellent results. It’s easy to use and a big time research saver. Try it and see what value (remember this part of StockCharts is FREE!) you get.

    Saul…

  63. owen November 6, 2010 10:48 am #

    Dave D, the short, flip, answer to your question about why I don’t go after the 40% return all the time is simple: the same reason I don’t put $40,000 on number 16 on a roulette wheel.

    In an option spread there is the possibility that both sides of the trade will expire. If I buy 100 shares of Apple at $302, and sell the $300 call, a drop to $270 will not kill me. I won’t be happy, but I may decide that it will come back and just hold on.

    If I had bought the Apple $290 call in order to sell the $300 call, and Apple dropped to $270, there is nothing to hold on to. My only recovery from that is just find something else that will earn me back the money.

    Barry’s comments in #59 need repeating. There is nothing about spreads that Alan does not understand. Not only does he not encourage BCI people to use them, he does not use them himself. He uses covered calls. Buy the stock, sell the call. Keep an eye on it. Collect your 2% or 3% for the month. Repeat. It’s simple. It’s easy to understand. It’s reasonably consistent. It’s profitable.

    Just as you should not be trading covered calls with all of your investing funds, you should not be using spreads as a substitute for all covered calls. Spreads are a choice for SOME (read small percentage) of your trading funds, IF you understand them. They are not the same thing. Close, but not the same. They do not have the same risk, that is why they do not have the same reward.

    I might bet $100 on red on a roulette wheel, because my odds are 47.3% that I will make 100% on my money. I wouldn’t put that $100 on number 16, because my odds are only 2.6% that I will make 3600%.

    Last, but certainly not least, if you find a broker that will let you trade more than covered calls in an IRA account, spreads are definately not safe. YOU CANNOT REPLACE LOST IRA FUNDS! Stick to a modest 2% a month in an IRA, and retire ten years earlier than the next guy.

    Okay. I think we have discussed the heck out of spreads. Now, back to covered calls.

  64. DaveD November 6, 2010 5:41 pm #

    Thanks for the update Saul…

    I will check it out…

    Cheers

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