beginners corner

Probability Analysis when Using Covered Call Writing or Selling Cash-Secured Puts

Whether we are selling covered calls or cash-secured puts we frequently look to our broker platforms for ways of enhancing our trading success. As these platforms become more sophisticated and competitive, there are a myriad of software analytical programs offered including those geared to probability analysis. A typical program will use implied volatility stats to determine the likelihood of an option strike price ending in- or out-of-the-money. The implied volatility figures are generated from option-pricing models like the Bjerksund-Stensland Model. Now, when we write covered calls, it would be useful to know the likelihood of a stock price dipping below the breakeven. So, the question becomes how beneficial are these programs and should we invest time and effort into them or devote our attention to other areas?

Recently, Miguel sent me an email asking about probability analysis for a successful trade. Since these programs rely so heavily on implied volatility, let’s define implied volatility and distinguish it from historical volatility.



Historical volatility is the actual price fluctuation as observed over a specific time frame. More specifically, it is the annualized standard deviation (discussed below) of past stock price movements.

Implied volatility is a forecast or market opinion of the underlying security’s volatility as implied by the option’s prices in the current market. It is typically based on one standard deviation (accurate 68% of the time) and on an annualized basis. Therefore, if the implied volatility is 25% for a stock trading at $60.00, it is expected to have a price range between $45.00 and $75.00, 68% of the time over the next one year. The higher the implied volatility, the greater the potential trading range and therefore the higher the risk of an unsuccessful trade (moving below the breakeven). The information generates a range, not a direction and those stats are correct 68% of the time, by definition (with the caveat that the number of standard deviations can also be adjusted, but one is most typical a shown in the brown highlighted area below).

implied volatil;ity and standard deviation

Standard Deviation Bell Curve

What is a successful covered call trade?

In my view, the best way to define a successful trade is one that generates a profit that meets our targeted goal. Some might define it as a trade that makes money. There are different perspectives. I have many friends that define a successful day at the casino as one where they only lost the money they brought…different strokes for different folks.

If we ascribed the chance of a stock price going up or down, we would say the chance is 50/50. Since we are starting of with an option premium and a breakeven below current market value, it is not unreasonable to say our chances of successful covered call trades are greater than 50/50.


80% chance of success

Here are the 5 things that can happen to a stock price:

  • Price moves up substantially
  • Price moves up a small amount
  • Price remains the same
  • Price moves down less than the option premium amount
  • Price moves down substantially

The first 4 result in a successful trade if we define such a trade as one that makes money. What becomes apparent is that the amount we lose in the fifth scenario is a major factor in our overall strategy success. Maximizing gains and mitigating losses are key elements in our exit strategy arsenal.


Probability analysis and the moneyness of the strike at expiration

The strike ending in-the-money or out-of-the-money can be a positive or a negative depending on strategy goals. For example, if we didn’t want to have a stock sold because of potential tax consequences, it would be helpful to know the probability of ending in-the-money. We may want to move the strike further out-of-the-money depending on our risk-tolerance.


The major missing element in probability analysis

The software programs do not factor in position management. Taking advantage of exit strategy opportunities changes everything and renders probability stats inaccurate. Proactive, non-emotional management of our option-selling trades results in the probability of successful trades so much greater than the non-managed projections of these software programs.


Factors more important then probability analysis

  • Stock selection
  • Option selection
  • Position management
  • Overall market assessment



Probability analysis has its place when selling options but, in my humble opinion, it is not a factor we should hang our hats on. By setting an initial return goal based on our personal risk tolerance we can manage our implied volatility risk exposure. The higher the time value initial returns for near-the-money strikes, the greater the risk. I have found my sweet spot to be between 2 – 4% per month for initial returns. I use lower implied volatility securities in my mother’s account where I target 1-2% per month. To sum up, the chances of successful covered call trades are greater than 50%, perhaps as high as 80% but the degree of our losing positions will impact our net final results.

Thanks to Miguel for providing the motivation for this article.


Upcoming live events

1- April 12, 2017

3:30 – 4:30

Income Generation Webinar for the Options Industry Council

Information and link to register


2- April 13, 2017

8:30 AM

Alan will be interviewed on Benzinga Pre-market Radio Network regarding the best strategies to use in the current market environment.

Information and link (scroll down to bottom of page)


Market tone   

Global stocks were little changed this week despite geopolitical concerns following the US missile strike on a Syrian airbase and a potential shift in tactics by the US Federal Reserve later this year. Oil prices solidified after the attack, with West Texas Intermediate crude rising to $51.94, up from $50 a week ago. Volatility, as measured by the Chicago Board Options Exchange Volatility Index (VIX), remained historically low, at 12.87 on Friday versus 12.37 a week ago. This week’s reports and international news of importance:

  • US payrolls expanded by 98,000 in March, well below the 180,000 expected
  • In addition, both January and February payrolls were downwardly revised
  • However, the unemployment rate dipped 0.2% to 4.5%, the lowest level since May 2007, while average hourly earnings rose 2.7% versus a year ago, down from 2.8% in February
  • In response to a chemical weapons attack in Syria by the regime of Bashar al-Assad, the United States launched nearly five dozen Tomahawk cruise missiles targeted at the airfield from which the attack is believed to have been launched
  • US president Donald Trump and Xi Jinping, China’s president, held talks at Trump’s Mar-a-Lago Club in Palm Beach, Florida. The leaders discussed trade relations between the world’s two largest economies as well as security concerns, particularly over North Korea
  • The minutes of Federal Open Market Committee discussed shrinking the Fed’s $4.5 trillion balance sheet beginning late this year by allowing some of the assets it acquired in the wake of the financial crisis to mature. However, the committee did not outline specifically how it will change its reinvestment policy. Those specifics are expected later in 2017
  • The eurozone purchasing managers’ index in March rose to its highest level in nearly six years, reaching 56.2 from 55.4. That’s the highest since April of 2011
  • European retail sales rose solidly for the second month in a row in February, rising 0.7%
  • In the United States, the Institute for Supply Management’s manufacturing index eased to 57.2 in March from February’s 57.7
  • Credit rating agencies Standard and Poor’s and Fitch each downgraded South Africa’s sovereign credit rating one level to BB+ in the wake of the sacking of former finance minister Pravin Gordhan. Weakening standards of governance and public finances were to blame




  • None scheduled 


  • Job openings Feb. 


  • Import price index March
  •  Federal budget March  


  • Weekly jobless claims 4/8
  • Producer price index Marsh 


  • Consumer price index March 
  • Core CPI March 
  • Retail sales March
  • Consumer sentiment April
  •  Business inventories Feb.

For the week, the S&P 500 moved down by 0.30% for a year-to-date return of 5.21%. 


IBD: Uptrend under pressure

GMI: 4/6- Buy signal since market close of November 10, 2016

BCI: I am currently favoring in-the-money strikes 2-to-1


The 6-month charts point to a neutral to a cautiously bullish outlook. In the past six months, the S&P 500 was up 10% while the VIX (12.87) declined by 5%.


Wishing you the best in investing,

Alan ([email protected]) and the BCI team



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.

24 Responses to “Probability Analysis when Using Covered Call Writing or Selling Cash-Secured Puts”

  1. David April 8, 2017 4:12 am #

    Hi Alan,

    quick question for you:

    how do you apply and calculate the 20/10 rule for ITM strikes?

    For example, I am in the second half of the holding period for an ETF that is currently trading at 235.52. I bought the shares at 233.86 and sold a contract at a 234 strike price for 2.28 and it is currently trading at 1.99.

    Am I looking for the delta between the original option premium (2.28) and current (1.99), which would be 87% and definitely NOT a green light?

    Or, is there some other calculation since it is ITM?

    thanks and best,


    • Jay April 8, 2017 6:11 pm #

      Hi David,

      Yours sounds like a typical ETF covered call trade these days. Due to the low volatility environment there is not much premium for level beta ETF’s. But you structured a low risk trade that might almost keep pace with SPY on the upside and surely beat it on the downside. By your prices I am guessing SPY is the ETF you used :)?

      To use this as an example for some of our friends who are new here: you bought at 233.86 and sold the 234 for Apr expiry. An ATM option with 14 cents upside. You received 2.28 plus your 14 cents upside so before exit strategies your one month return is 2.34 cents or the 1% Alan mentioned.

      SPY has gone up a bit more than 1% a month this year but if it backs off you will have $2.34 downside help and keep your shares in two weeks. Since we are now entering the last two weeks SPY would have to drop reducing your option value to 23 cents before the ten percent rule would trigger for a cheap buy back.Then you would be free to do what you wish with SPY, sell, hold, roll out, roll down, etc..

      If I am wrong and your ETF is not SPY I would love for you solve a riddle for me and tell me the actual ticker :). – Jay

  2. Alan Ellman April 8, 2017 7:56 am #


    The 20/10% guidelines apply to all strikes. If share price declines (not the case here), ITM strikes will decline in value to a greater extent than OTM strikes because they have higher Deltas.

    In this example, the applicable value or threshold to buy-to-close is 10% of $2.28 or $0.23 (a few pennies in either direction is okay as it is a guideline). Since the current value is $1.99, we are not even close to considering closing the short call.

    At this point in time, all looks well for the 1%, 1-month return.


  3. Roni April 8, 2017 5:00 pm #


    Amazing !!
    Each and every article you post, is another brick in the foundation of my trading strategy. (the BCI methodology)

    Thank you, I really apreciate it – Roni

  4. Justin P. April 8, 2017 9:04 pm #

    A much faster way to view and compare ROO’s for an option chain: using the setup in the diagram you can just copy and paste a whole chain’s data into a spreadsheet (and enter the latest price in A1) and you’re done! 🙂

  5. Yaw April 9, 2017 4:25 am #


    I am new to options and I just chanced to hit your website. What a wealth of information you have for beginners!

    Alan, the 20%/10% rule is not quite clear to me. When you talk about ” buying back 20% in the first cycle of the contract”, what do you mean by the first cycle. How many cycles does a contract have?

    Still learning.


    • Alan Ellman April 9, 2017 7:51 am #


      Each year there are 8 Monthly contracts that last 4 weeks and 4 Monthly contracts that last 5 weeks. By the first half of a contract cycle, I refer to the first 2 weeks of a 4-week contract and the first 3 weeks of a 5-week contract. The second half of the contract cycle refers to week 3 of a 4-week contract and week 4 of a 5-week contract.

      If we sold an option initially for $2, we would buy it back if premium value declined to (about) $0.40 or less in the first half of the contract cycle. We change this threshold to $0.20 or less in the second half of the contract cycle. These guidelines guarantee that we retain at least 80 – 90% of our initial premium profits.

      Welcome to our BCI community.


  6. Geoff April 9, 2017 1:31 pm #

    Alan, another awesome article! I wish I knew how to communicate the way that you do because you’re very clear, concise, and ordered.

    You hit all of the high level topics very well. And you managed to avoid all the massively technical finance jargon and statistics jargon. That’s where I would tend to stumble. Somehow I’d start getting into fat tails, normal distributions, Gaussian distributions, and confidence intervals and have completely lost the audience by the second paragraph.

    I’ve really done well with the BCI system and have very much enjoyed my membership. It’s well worth the price to have so much parsed down into an actionable stock list. And, the Blue Hours have really expanded my understanding of some topics of interest. I feel like the stock list helps my chances of success quite a bit because first look may be from a few sources which include IBD but then your folks (like Barry) parse the data again and finally I look at it and throw out some trades and make some trades. By the time it’s been filtered through all those lenses I believe I have a bit better odds than the dart board setup and my trading results have been demonstrating that in spades. There are certainly trade setups I’ve seen that I just toss to the waste basket because it doesn’t look good to me. Others, I’ve managed well. Finally, one of my most profitable trades was based on keeping myself “inside” the BCI system rules. The system “forced” me to take a bit of a more aggressive strike than I probably would have selected but trading rules are only good if you follow them. Bouncing around and changing things also changes the odds of success. Anyway, I took an ETF trade (put sale) one strike higher than I really wanted to and ended up being assigned by a thin margin. At the moment, I was a bit bothered because I could have taken a 100% gain and moved on 1-strike lower. However, I had been looking at the call prices on expiration week and decided that if it didn’t bleed out too much more I could keep it moving in the right direction. Long story short, I was +0.17 per contract on the exercise and then, risk worked in my favor, the ETF bounced heavily to the upside on Monday and I sold a call which I rolled, (and rolled out and up) for a few months before deciding to finally close the position. Net results were excellent at over 26% gained.

    My other big learning lesson was having a great run with a position just looking fantastic all the way to expiration week Wednesday where the stock just collapsed. I closed it out for a 1% loss (stock and option combined) and then it launched back on Thursday and Friday to max profit (which I couldn’t be in for). I’ve learned to watch the volatility and whipsaws on expiration week as market makers (and institutional investors) are trying to hedge out exposure. I got whipsawed out of what would have been an amazing trade. But, live and learn in the position management department.

    Anyway, again, great article!

    • Jay April 9, 2017 2:45 pm #

      Hey Geoff,

      I am an old buzzard on this comment board :).

      Thank you for joining us with your insight laden commentary, command of options trading and great real time trade examples!

      Your every post makes us smarter. Please keep them coming!

      It’s baseball season so I will hazard an analogy: singles win more games than home runs :).

      By that I mean if you have a portfolio write calls on part of it . You will do better than if you didn’t. Don’t write calls on everything – you will cut your nose off to spite your face!

      And flex the strikes more towards ATM and ITM since you have the rest of your positions to run free.

      Sergio Garcia is about to tee off as I write. I hope he wins The Masters. A nice guy over due. – Jay

    • Alan Ellman April 11, 2017 7:55 am #


      Thanks for sharing your trades, ideas and for your contributions to this blog.

      If you or any of our members have specific trades (successful or otherwise) that represent constructive learning experiences, please send them to me privately [email protected]) as I may use them in a blog article or “Ask Alan” video.

      Because of you, our members, I have been able to write weekly articles and produce monthly videos over the past 11 years.


  7. Luis April 9, 2017 5:58 pm #

    Alan, hello, I am a new member. I have scoured the site, read every article and watched just about every video I can get my hands on.

    There is something I just don’t get.

    I want to hold the various SPDR sector ETFs, cycling thru them as they are in their strong trends.

    Lets assume I sell an OTM call with a $1 premium. At 3:50 PM the day of expiration, the option is $5 ITM, now valued at $5.00.

    Since this is my preferred ETF at the time, I roll up and out and get another $1 in premium.

    The way I understand this is that I am at a -$3 debit (+$1 -$5 +$1).
    I understand the returns and upside, but the question is in the mechanics of the brokerage account.

    I have a gain on the ETF of $5 with a net debit of -$3, but that gain is on paper. So until I eventually sell this ETF, my unrealized gain increases (not available to trade) and I have to continue to shell out cash as the trend continues, correct?

    This is very scary, as I could have rolled 4 or 5 times, then all of the sudden, the ETF turns and the unrealized gain that was supposed to cover all those debits is now gone.

    I know you are busy, I hope you find time soon to reply.

    Trade long and prosper.
    Luis from Phoenix Arizona.

    • Alan Ellman April 10, 2017 7:21 am #


      When we buy-to-close an ITM strike, the intrinsic value of the closing option is responsible for the increase in current market value of our shares. If we are calculating in the option debit, we must also calculate the share credit that the debit created. Since we are re-evaluating our positions monthly (some members use Weeklys), we make frequent decisions as whether to include this security in the upcoming option-selling portfolio. We also have our exit strategy arsenal to mitigate whenever trades turn against us.

      That said, let’s we bought an ETF for $28 and sold the $30 call for $1 and at expiration the security was trading at $35. That would represent a 10%, 1-month return. Now the question becomes whether to roll out-and-up to the $35 strike for a $1 premium. In your hypothetical, the cost-to-close is $5 (probably will be $5.05 but let’s say $5). Since our shares are worth now $30, this is the same scenario as buying the shares for $35 and selling the ATM strike for $1 or a 2.8%, 1-month return.

      “To roll or not to roll, that is the question”

      That’s decision is based on current market stats and information and has nothing to do with our initial purchase price or previous option credit.


  8. Jay April 9, 2017 6:25 pm #


    I’ll let Alan or Geoff address your questions. I suggest a change to your log off:

    Trade small, trade both directions and prosper 🙂 – Jay

  9. Barry B April 10, 2017 1:57 am #

    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 04/07/17.

    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:


    Barry and The BCI Team

  10. Jay April 10, 2017 9:56 pm #

    I can not put my finger on it. I can not show you a chart that justifies it. It is pure hunch from being in the market a long time: I don’t like this April.

    I am covering my positions ATM on up days. There is no risk in that. FED meets first week of May. I want to be uncovered for that. – Jay

    • Justin P. April 11, 2017 12:19 am #

      You’re expecting a jump during the Fed meeting Jay?

      • Jay April 11, 2017 8:04 am #

        Hi Justin

        No, I really do not know what to expect from the Fed, it is just one of those events that tends o move the markets.

        Of course, if you sit out every Fed meeting, election cycle, international event, earnings report and ex dive date pretty soon you fritter away a lot of time so there needs to be a balance in there somewhere 🙂

  11. Justin P. April 11, 2017 4:47 am #


    I’m just checking out some options to see how much value there is with only a few trading days left in the monthly contracts. I gather from your articles that at this stage you prefer to go with ITM strikes if opening a new position. With that in mind, would the $46 strike in LITE be your preferred choice if you had to choose from it’s available strikes? The ROO at $2.15 would be 2.2% with Downside Protection of 2.4%. The $44 strike at 2.0% looks a lot safer but only has OI of 8 contracts so I’m assuming that wouldn’t meet your criteria. And considering how few days there are left, maybe the $45 strike at 1.5% with lots of OI might be best. Or maybe none of these strikes would look attractive to you? 🙂

    Justin P.

    • Alan Ellman April 11, 2017 3:40 pm #


      I can’t give specific financial advice in this venue but I can offer some ideas that should be useful:

      1- All the strikes you mention are in play expect the $44 strike which does not have adequate option liquidity and too wide a bid-ask spread.

      2- Because there are only 10-days remaining until expiration, I tend to favor ITM strikes that also offer a minimum of a 1%, 10-day return. Those with higher risk tolerance may favor OTM strikes.

      3- When selling ITM strikes late in a contract, the lower the time value returns means downside protection is greater.

      I would set a minimum time value return requirement and then view those strikes that offer the greatest downside protection of that initial profit.


  12. Alan Ellman April 11, 2017 3:22 pm #

    Events this week

    1. Wednesday at 4:30 PM ET

    Portfolio Overwriting for the Options Industry Council

    (to register)

    2. Thursday at 8:35 AM ET

    Benzinga Radio pre-market interview

    (scroll down to bottom of page)

  13. Alan Ellman April 11, 2017 10:04 pm #

    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.

    For your convenience, here is the link to login to the premium site:

    NOT A PREMIUM MEMBER? Check out this link:

    Alan and the BCI team

  14. Alan Ellman April 11, 2017 10:06 pm #

    Next Blue Hour webinar:

    FREE to premium members and available to purchase for non-members.

    Thursday April 27th 9 PM ET

    Registration link coming soon.

    Evaluating Mutual Fund Portfolios and Financial Advisors
    Plus: The Top 5 Option Questions from 2016

    This is a 2-part webinar presentation:

    1: Many of us hold portfolios of actively-managed mutual funds that we’ve either selected ourselves or, more likely, been based on financial advisor advice. This webinar will provide a user-friendly technique to evaluate the performance of these portfolios and hence the performance of our financial advisors. We should commend those advisers who are out-performing the overall market and certainly question those who are under-performing the market and charging us fees to fall short. “Indexing will be defined and explained and a system to set up comparison charts (FOR FREE) will be highlighted.

    2: The BCI team has gone through thousands of questions sent to us in 2016 and selected the top-5 most frequently asked questions to ask and answer in the second part of this webinar.

    As always, written questions will be answered live by Barry Bergman, the BCI Director of Research, while Alan hosts the presentation.

  15. Michael March 26, 2021 11:51 pm #

    Hey Alan, great information, very clear. I’m still a little fuzzy on calculating IV and EV when selling a Covered Call or selling a Cash Securred Put. Is it just the reverse of that which you use to calculate puchasing a Call or Put ? Thanks for the help. Big Fan.

    • Alan Ellman March 27, 2021 7:19 am #


      The implied or expected volatility of an option (for any option strategy) tells us, based on current option pricing in he market place, how much the underlying security is anticipated to move in either direction.

      As the article describes, this is not an exact science as it is based on 1 standard deviation… so expected to be accurate 68% of the time.

      We do not need to make these calculations. They can be accessed from our broker platforms or free sites like

      When selling covered calls or cash-secured puts, the IV will dictate the amount of option premium we receive and also give us a measure of the risk in our trades.

      Instead of looking up IV stats we can assume the appropriate risk for our trading style and personal risk-tolerance by staying within a well-defined initial time-value return goal range. For me, it’s 2% – 4%/month for near-the-money strikes. I’ll go as high as 6% in strong bull market environments. Never higher.

      Understanding IV is critical. Managing IV will put cash in our pockets.


Leave a Reply

Optionally add an image (JPEG only)