One of our covered call writing-like strategies is portfolio overwriting. The strategy involves selecting deep out-of-the-money (OTM) strikes that will generate lower returns than traditional covered call writing but also decreases the likelihood of exercise (our shares being sold). The returns will still be significant when annualized, while still enhancing the probability of avoiding exercise and retaining the shares.
Basis of strike price selection
Since share retention is a priority goal, we will select only out-of-the-money strikes with Deltas between 0 and .50, the closer to “0” the better. Next, we must determine what our annualized return goal is over-and-above typical share appreciation and dividend income. Let’s say our portfolio is appreciating 6% per year plus an additional 2% per year from dividend distributions. We may set a goal of an additional 6% per year for a total average annualized return goal of 14%. If we are using Monthly options, that would compute to 0.50% per-month. If we are using Weeklys, it would result in a 0.12% weekly initial time value return goal.
Can we set our monthly goal from 1/2% per-month to 1 1/2% in high IV conditions?
This is tempting but the strike in normal market conditions that generates 1/2% is quite different from the strike that will generate 1/2% in high IV conditions. We must keep in mind our stated portfolio overwriting mission of retaining the shares.
Option premiums in high IV markets
The time-value component of option premiums is directly related to implied volatility. If IV increases, as it did in April of 2022, the corresponding option premiums will also rise.
Delta in high IV markets
Since the expected trading range for high IV securities is much greater than that of normal market conditions, the Deltas of the corresponding strikes will also increase as the probability of expiring with intrinsic-value is enhanced. Therefore, the strikes must be adjusted higher to preserve stated goal of a low probability that the strike will expire ITM.
Real-life example for a 1-month expiration for Microsoft Corporation (Nasdaq: MSFT): ($272.99)
MSFT: Option-Chain on 4/22/2022
- To achieve a return of 1 1/2% of $272.99 or about $4.09 ($4.00 brown cell), we would look to the $295.00 strike which has a Delta of 24.88% (pink cell), about a 25% probability of expiring ITM and resulting in exercise with no exit strategy intervention
- To achieve an initial return of 1/2% of $272.99 or about $1.36 ($1.12 and $1.59 in the yellow cells), we would look to the $310.00 and $315.00 strikes which have Deltas of 11.77% and 8.97%
- Our investment decisions and trade structuring depend on these 2 factors
Discussion
Portfolio overwriting has 2 main stated goals. We seek to generate lower but significant annualized returns while establishing a low probability of the option expiring ITM. In high IV market environments, we may be tempted to use similar strikes we would have selected in normal market conditions, but Delta will play a role in making such decisions higher risk.
Click here for a related article.
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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:
Alan,
I purchased your book, The Complete Encyclopedia for Covered Call Writing. Great book, very well done and leaves nothing out.
Thanks,
Stephen
Upcoming events
1.Wealth365 Investor Summit
Thursday October 13, 2022 (this coming Thursday)
Using Both Covered Call Writing and Put-Selling to Generate Monthly Cash Flow
The PCP Strategy (Put-Call-Put or “wheel” strategy)
Hosted by:
Dr. Alan Ellman, President of The Blue Collar Investor Corp.
Barry Bergman, BCI managing Director
Selling stock options is a proven way to lower our cost-basis and beat the market on a consistent basis. Two such low-risk strategies are covered call writing and selling cash-secured puts. This presentation will detail how to incorporate both strategies into one multi-tiered option-selling strategy where we either generate cash-flow or buy a stock at a discount. I refer to this as the Put-Call-Put (PCP) Strategy, also referred to as the wheel strategy.
The basics and pros and cons are discussed as well as a real-life example and introduction into the BCI PCP Calculator. This seminar is appropriate for those who look to generate modest, but consistent, returns which will enable us to beat the market on a steady basis while focusing in on capital preservation.
2.Money Show Orlando live event
October 30th – November 1st, 2022
OMNI ORLANDO RESORT AT CHAMPIONSGATE
Visit Alan, Barry and members of the BCI team at Booth # 415
Sunday, October 30, 2022, at 5:00 pm – 5:45 pm EDT
Covered Call Writing: Multiple Applications Based on Current Market Conditions
Monday, October 31, 2022, at 4:30 pm – 6:30 pm EDT
Selling Cash-Secured Puts: Detailed Start-to-Finish Six-Part Program*
Masters Class
Comprehensive Course on Selling Cash-Secured Puts
Detailed start-to-finish 6-part program
This presentation will provide all the information, with real-life examples, necessary to master the strategy of selling cash-secured puts. The program is divided into 6 sections:
- Section I:
- Option basics
- Section II
- Traditional put-selling
- Section III
- PCP (wheel) strategy
- Section IV
- Buy a stock at a discount instead of a limit order
- Section V
- Ultra-low-risk put/Delta strategy
- Section VI
- Ultra-low-risk put/Implied volatility strategy
This presentation was developed to benefit both beginner and experienced option traders and will provide all the information needed to initiate the strategy and elevate returns to the highest possible levels.
45-minute presentation
Covered Call Writing: Multiple Applications Based on Current Market Conditions
Real-life examples with Invesco QQQ Trust (Nasdaq: QQQ)
Covered call writing is a low-risk option-selling strategy geared to generating cash flow with capital preservation a key requirement. This presentation will demonstrate how the strategy can be crafted to benefit in all market environments. Market situations highlighted are:
- Normal to bull markets
- Bear and volatile markets
- Low interest-rate environments
A popular large-cap technology exchange-traded fund, Invesco QQQ Trust, will be used to establish rules and guidelines to benefit in these market circumstances.
3. Money Show’s Post-Election Strategies Virtual Expo
November 10th -11th, 2022
Information & registration link to follow
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Market tone data is now located on page 1 of our premium member stock reports and page 1 of our mid-week ETF reports.
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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 10/07/22.
Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them on The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:
http://www.youtube.com/user/BlueCollarInvestor
Reminder: Premium members are grandfathered into your current rate and will never see a rate increase as long as the membership remains active.
Best,
Barry and The Blue Collar Investor Team
[email protected]
Alan,
Can you explain why you change 20% to 10% in your exit strategy rules? Is it based on your experience or some sort of formula?
Thanks,
Lou
PS: your videos are the best in the business!
Lou,
Thanks for your kind words.
The answer to your question is “both” … experience + an understanding of one of the option Greeks … Theta.
Back in the late 1990s, I realized that Theta (time-value erosion) created more opportunities to generate additional time-value premium early in a contract rather than later in a contract. This meant that we should be willing to spend more money to close a short call earlier and less money later in a contract. I just didn’t know the specifics.
I spent a few years of trial and error to get the specific percentiles and timing before publishing the BCI 20%/10% guidelines which I still use to this day. It’s a staple in all of my covered call writing portfolios.
By the way, we also have the 20%/10% guidelines for puts which is implemented when share price accelerates. All this exit strategy information is detailed in my new exit strategy book and in our new TMC Package.
Alan
Premium Members,
The Ex-Div date for NOG has been updated in the report dated 10/07/22. The correct date is 09/28/22, not 10/14/22.
Best,
Barry and The Blue Collar Investor Team
[email protected]
Hello Alan,
Watching your video on Covered Call Writing in Bear and Volatile Markets and trying to think this thru.
Could you also sell puts against the inverse ETF’s (PSQ,DOG, SH) as a strategy in a volatile/bearish market?
And further diversify by only using one of the ETF’s combined with the other two strategies (low beta and ITM strikes) in the video.
Thanks,
Jon
Jon,
Yes, when we determine the need for ultra-defensive strategies based on current market conditions, we can use one or all of those strategies.
The implementation of inverse ETFs should be favored in confirmed bear market conditions or to hedge in volatile market conditions. I’ve used inverse ETFs a few times this (challenging) year.
Alan
Alan,
Thank you so much for the great content on YouTube. I purchased and read one of your books and I have another on order.
I’m most interested in writing covered calls on a long stock position that I already have. However I can see a scenario in which I might want to write five contracts at the same strike price on the same expiration date, maybe 10.
At what point should I be worried about liquidity as it relates to volume and open interest? I think I remember you saying that you prefer to see at least 100 in open interest but that might be for writing one contract. Any thoughts?
Tony
Tony,
No need to be concerned as long as we follow the BCI guidelines of at least 100 contracts of open interest and/or a bid-ask spread of $0.30 or less. 1 -10 contracts are typical for the members of the BCI community.
As long as the initial premium meets our stated initial time-value return goal range, option liquidity comes into play if we need to execute an exit strategy and buy back that option.
To enhance our bid-ask spread positions, we can also leverage the “Show or Fill Rule”
https://www.thebluecollarinvestor.com/how-to-negotiate-better-option-prices-using-the-show-or-fill-rule-30-rebate-expiring/
Alan
Premium members:
This week’s 4-page report of top-performing ETFs and analysis of the top-performing Select Sector SPDRs has been uploaded to your premium site. One and three-month analysis are included in the report. Weekly performance has also been incorporated into the report although not part of the screening process. Weekly option availability and implied volatility stats are also incorporated.
The mid-week market tone is located on page 1 of the report.
New members check out our ongoing and never-ending training videos (“Ask Alan” and Blue Hour webinars). We add at least one new video each month. Only premium members have access to the entire library of these training tools.
Reminder: Premium members are grandfathered into your current rate and will never see a rate increase as long as membership remains active.
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Alan and the BCI team
Hello Alan,
Sorry to bother you with this but can you direct me as to where I can read the answer to the following:
How do I enter trades in the Trade Management Calculator where I purchased stock/sold cc and then within the same week rolled down at same expiration date , and then rolled up and out to following month at higher strike price?
The volatility is keeping me busy.
Thank you
Bob
Bob,
These 3 trades would be archived on 2 separate spreadsheets. I save and archive my trades based on contract expirations. For example, I will save my current monthly portfolios and name it “TMC_10-21-22.
In your example, the initial trades of selling the covered call & rolling-down would be on the current month spreadsheet and the rolling-out-and-up trade would be found on the next expiration spreadsheet.
For detailed information on this topic see Chapter 12 and Appendix IV of my new book, “Exit Strategies for Covered Call Writing and Selling Cash-Secured Puts”
Alan
Premium Members,
The Weekly Report for 10/14/22 will be delayed until Monday, 10/17/22. The IBD website is undergoing scheduled maintenance from 8:00 PM ET on Friday, 10/14/22 through 2:00 AM ET on Monday, 10/17/22. Our goal is to have the report out by mid-afternoon on Monday, 10/17/22…but we will make every effort to get it out sooner.
Best,
Barry and The Blue Collar Investor Team
[email protected]