Exit strategy preparation and implementation is one of the 3 required skills for successful covered call writing and put-selling. Because of the time value erosion of our options (Theta), there are limitations regarding the exit strategy opportunities as our contracts near expiration. In January 2018, Duminda contacted me about a trade he executed with Five Below, Inc. (NASDAQ: FIVE) that appeared to head south late in the contract month.
Duminda’s trade
- 12/18/2017: Buy 100 x FIVE at $68.66
- 12/18/2017: Sell 1 x $70.00 call at $2.25
- 1/8/2018: FIVE gaps down to $65.00 on a downbeat profit forecast
- 1/8/2018: The cost-to-close the $70.00 call is $0.80
- 1/18/2018: Stock price is $66.96 (the day this article is being written)
FIVE gap-down in January 2018
FIVE Chart Showing Price Decline in January 2018
Exit strategy opportunities?
Buy-to-close the short call
Since we are in the second half of the January contracts, the 20%/10% guidelines for closing the short call points us to a buy-to-close price in the $0.23 area (10% of $2.25). The current cost–to-close is $0.80, well above that threshold.
Close the entire position if news is egregious or well-under-performing the S&P 500
Although negative earnings guidance can cause a temporary hit in share price, it can also be related to creating a softer landing when the actual earnings report is released. Also, the stock started to rebound shortly after the gap-down. The stock was slightly under-performing the S&P 500 when viewing a 1-month chart (+2% to +5%), also not enough of a discrepancy to make selling the stock an obvious path to take.
FIVE and S&P 500 Comparison Chart
Take no action
Given that the 20%/10% guidelines were not met, the stock price began to recover and the 1-month comparison chart with the S&P 500 was not strongly bearish, this is a reasonable path to consider.
Calculations
Initial time value return (ROO)
$2.25/$68.66 = 3.3%
Cost-to-close on 1/8/2018
$0.80/$68.66 = 1.2%
Trade results as of 1/18/2018 taking no action
$225.00 (option premium-per-contract) – $170.00 (current share value loss) = + $55.00 = 0.8% 1-month return = 9.6% annualized
Discussion
Position management implementation may not always be obvious. By adhering to a structured system that has its basis in sound fundamental, technical and common-sense principles, we will make the best choices in most circumstances. In this article, we used fundamental news, review of price charts, comparison charts and use of our 20%/10% guidelines to determine that sometimes the best action is no action at all.
Thanks to Duminda for sharing this trade with our BCI community.
New videos available
The BCI team recently uploaded 2 more videos to your member sites:
Blue Hour 10: How to Generate Monthly Cash Flow and Buy a Stock at a Discount Using 2 Low-Risk Option Strategies
Ask Alan #149: How to Structure Portfolio Strikes
Upcoming events
Denver Colorado: American Association of Individual Investors
August 18 @ 9:00 am – 12:00 pm
Saturday August 18, 2018
Click for information and registration details
San Francisco Money Show
August 23 @ 10:00 am – 11:00 am
Hilton San Francisco Union Square
1.Thursday August 23rd: 12:30 PM – 1:15 PM
All Stars of Options: “How to Select the Best Covered Call Options in Bull and Bear Markets”
2. Friday August 23rd: 10:15 AM – 1:15 PM
Masters Class: “How to Generate Monthly Cash Flow and Buy a Stock at a Discount Using 2 Low- Risk Option Strategies (covered call writing and selling cash-secured puts)”
3. Friday August 23rd: 6:00 PM – 6:45 PM
Workshop: “Converting Non-Dividend Stocks to Dividend Stocks using Stock Options”
Market tone
This week’s economic news of importance:
- Job openings June 6.7 million (6.7 million last)
- Consumer credit June $10 billion ($24 billion last)
- Weekly jobless claims 8/4 213,000 (217,000 expected)
- Producer price index July Wholesale inventories June 0.0% (0.2% expected)
- Consumer price index July 0.2% (as expected)
- Core CPI July 0.2% (as expected)
THE WEEK AHEAD
Mon August 13th
- Survey of consumer expectations July
Tue August 14th
- NIFB small business index
- Import price index
Wed August 15th
- Retail sales July
- Productivity Q2
- Industrial production July
- Home builders’ index August
- Business inventories June
Thu August 16th
- Weekly jobless claims 8/11
- Housing starts July
- Building permits July
- Philly Fed Index August
Fri August 17th
- Consumer sentiment Aug
- Leading economic indicators July
For the week, the S&P 500 moved down by 0.2% for a year-to-date return of 5.97%
Summary
IBD: Market in confirmed uptrend
GMI: 6/6- Bullish signal since market close of July 9, 2018
BCI: Using an equal number of in-the-money and out-of-the-money strikes. Impact of foreign currency issues, tariffs/trade wars unclear.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
The 6-month charts point to a bullish tone. In the past six months, the S&P 500 was up 6% while the VIX (13.16) down by 48%.
Wishing you much success,
Alan and the BCI team
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 08/10/18.
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
Since we are still in Earnings Season, be sure to read Alan’s article,”Constructing Your Covered Call Portfolio During Earnings Season”. You can access it at:
https://www.thebluecollarinvestor.com/constructing-your-covered-call-portfolio-during-earnings-season
I will be out of the country from 8/18/18 through 8/25/18. My destination has decent internet, so you can expect the report for 8/17/18 to be out on Sunday, possibly earlier. The report for 8/24/18 will be out before the opening on Monday, 8/27/18. Most likely, I should be able to get it out to you late on Sunday evening, 8/26/18.
Best,
Barry and The BCI Team
[email protected]
Alan,
Would you have taken action if option price dropped to $0.30. How rigid is the 10% rule?
Thanks,
Marsha
Marsha,
I refer to these 20%/10% thresholds as “guidelines” specifically to give members framework yet flexibility to this exit strategy. In the article, option price dropped to $0.80 which represents a 35% threshold, not close to the 10% guideline. Had it declined to $0.30, that would represent a threshold of 13%, I would consider buying back the call.
Alan
A gentle reminder for those of us who sell CSP’s: be cognizant of when they time decay down, Buy back and take profit when you have it. Please don’t just hold blindly to expiry – Jay
New Blue Chip Report now available:
Premium members,
The Blue Chip Report for the September 2018 contracts has been uploaded to your member site (right side). This report is a bit unusual in that only 6 of the DOW 30 stocks met our system criteria.
Alan
Alan,
Are your seminars eventually going to be available on your website for those who cannot attend in California?
Thanks,
Joanna
Joanna,
Yes, I am adding my live presentations to our premium and video member sites over time in the form of “Blue Hour Webinars”. There are currently 10 webinars and the BCI team will continue to add more. I am also constantly producing new presentations.
Premium and video members login to your member sites and scroll down to “The Blue Hour” webinars as shown in the screenshot below.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan
Alan,
How do you determine the percentages for itm and otm strikes?
Thanks,
Brian
Brian,
In normal market conditions (appreciating 7% – 10% per year), I will favor OTM strikes 3 to 2 or 2 to 1.
In consolidating (flat) markets, I will sell an equal number of ITM and OTM.
In strong bull or bear markets, I adjust accordingly.
The OTM strikes usually go with the stocks that have the strongest technicals (bold in our reports).
In bear markets, I will enter a covered call trade by first selling an OTM put.
These are guidelines, not rules.
Alan
Hi Alan,
I just finished reading the Complete Encyclopedia 1. So much great information that I actually understood. I started re-reading the book today. I never thought about avoid earning reports but will make it a key part of my investment program when selling options. You mention in the book that a covered call can be used after the report passes. My question is how long do we wait? Let’s say a report comes out tonight. Can we sell covered calls tomorrow?
Thanks for giving small investors so much confidence.
Penny
Penny,
Thanks for your generous remarks.
After an earnings surprise (either way), there is frequently price volatility. We wait for that volatility to subside and then consider selling the call or put. In your example, this may be during my personal preferred trading hours of 11 AM – 3 PM ET the next day or the day after.
Alan
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
Alan,
Quick question. In the most basic sense, isn’t it true that rolling out and or up accomplishes the same thing as buying back the option and then reselling another one after that? The only difference being that you would be paying double commissions in the latter case since it’s two separate transactions? The reason I ask is that my trading platform will only allow me to set a limit order on the option that I am selling when I want to roll. I don’t mind paying another five bucks for it to mean I get the prices that I want. Thoughts?
Joanna,
Rolling options is generally accomplished with 2 trades…BTC and then STO. We should set limit orders on both trades and leverage the “Show or Fill Rule” whenever possible.
Alan
Joanna,
most of the time I look at rolling out, or out and up on a successful trade, I end up deciding against it.
As you said, the extra commissions are insignificant, and the realized gain is cash in your pocket today.
Cheers – Roni