Covered call writing is defined as first purchasing or already owning the underlying security and then selling the corresponding call option. By doing so, we are protected; we know our cost-basis. A BCI member proposed to me an extreme bear market strategy where a deep out-of-the-money (OTM) call is sold first and if the stock appreciates significantly, against market trend, we can buy that security prior to the strike moving in-the-money. This article will analyze the pros & cons of such an approach.
Real-life example with SPY
- 6/17/2022: SPY trading at $365.40
- 6/17/2022: The $400.00 deep OTM 7/18/2022 call shows a bid price of $1.56 per-share
- 6/17/2022: Sell the naked call first and plan to purchase SPY if the price appreciates near the $400.00 strike
BCI Trade Management Calculator showing initial returns at the current and $400.00 price points
SPY: Reverse Covered Call Writing Calculations
The annualized returns whether shares are purchased or not, are between 4% and 5% (brown cells).
Strategy advantages
- In a bear market, holding long positions can result in significant losses
- Selling low-Delta, deep OTM calls have low probability of exercise
Strategy disadvantages
- The upside is the premium generated for a deep OTM call strike which, by definition for a security like SPY, would be miniscule
- If we are forced to buy the security as price approaches the deep OTM strike, the % return would be similarly miniscule, even a bit less (brown cells for 1st 2 bullets)
- Naked option trading requites a higher level of trading approval that most retail investors would have a difficult time obtaining
An alternative consideration
Sell deep OTM cash-secured puts that generate a pre-defined initial time-value return goal range because we know our cost-basis in advance (the cash required to secure that put trade). In this case, if the trade does turn against us and share price declines below the put strike, shares are purchased at a discount from when the trade was initially executed.
Discussion
There are many ways to craft our option-selling portfolios in extreme bear market conditions. Naked option selling is not appropriate for most retail investors even with a plan to purchase the underlying should the trade turn against us. In addition, it would be difficult to receive approval for such trading.
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Upcoming events
To request a private webinar for your investment club, hosted by Alan & Barry: info@thebluecollarinvestor.com
1. Mad Hedge Traders and Investors Summit
Thursday December 8th at 12 PM ET (registration link to follow)
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 as a key requirement. This presentation will demonstrate how the strategy can be crafted to succeed in all market environments.
Market situations highlighted are:
- Normal-to-bull markets
- Bear and volatile markets
- Low interest rate environments
This webinar will include specific methods to set up ultra-low-risk paths to set up trades with 84%+ probability of success.
2. Long Island Stock Traders Meetup Group (Private webinar)
Analyzing a 1-Month Covered call Writing Portfolio from Start to Finish
Thursday February 16,2023
7:30 PM ET- 9 PM ET
A real-life example with a $100k ETF Select Sector SPDR portfolio
Covered call writing is a low-risk option-selling strategy that generates weekly or
monthly cash flow. This presentation will demonstrate how to implement this
strategy using a database of only 11 exchange-traded funds for a 1-month option
contract cycle. These are real-life trades taken directly from one of Dr. Ellman’s
portfolios with screenshots verifying each trade. A final monthly contract result
compared to the performance of the S&P 500 will be calculated.
Topics included in this webinar:
What are the Select Sector SPDRs?
How to establish a covered call writing portfolio
What is the role of diversification?
What is the role of cash allocation?
Calculating initial returns
Analyzing each trade in the monthly contract
Final results
Next steps
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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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Alan,
I do mainly weekly options. Should I still place a buy to close limit order on my covered calls or just monitor since its only 5 days?
Thank you.
Randy
Randy,
If you can monitor your trades constantly over the 5-day contract cycle, there is no need to place a BTC GTC limit order.
For most of us who cannot be at our computer screen for a deal of the trading days, placing a 10% BTC GTC limit order makes sense as it partially automates the exit strategy process. Request an email or text notification from our brokers if any trades are executed. This will allow us to take next-step management.
Here is a link to one of many articles I published on this topic:
https://www.thebluecollarinvestor.com/hitting-a-double-on-the-last-day-of-a-contract/
Alan
Alan
Premium Members,
This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member site and is available for download in the “Reports” section. Look for the report dated 12/02/22.
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
barry@thebluecollarinvestor.com
Alan,
None of my 20% BTC limit orders have been breached either, but my SMCI OTM CC 12/16 $95.00 trade was nearing the limit. The stock had dropped nearly 7%, and therefore I decided to liquidate it at a mitigated loss of 5.8%.
I have immediately used the resulting cash to place an STLD 12/18 $110.00 OTM CC trade, and remain 100% invested this month.
Wishing for the best – Roni
Roni,
Thanks for sharing. Our premium member stock report shows STLD to have strong technical indicators, a bullish analyst rating (MAR) and favorable institutional trading (on balance volume). Let us know how this trade turns out.
It appears that 2022 is concluding in a much better place than when it started.
Alan
Correction: “STLD 12/16”
Premium members:
This week’s 5-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, mid-week market tone as well as the implied volatility of all eligible candidates.
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.
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Alan and the BCI team
Hi Alan,
Apologies if this is in the Q&A, I looked but didn’t see it addressed.
I’m using the covered call strategy; I’ve been buying back my sold call options when the price falls using the 20%/10% rule per your guidelines. Unfortunately, I find myself buying back approximately 25% of my sold options as sold option prices reach 20% or 10% of my initial sell price following your rules on how much time is left in the contract.
After I purchase my call options back to close the position, I’ve been holding the stock looking to “hit a double” as you say. But I usually don’t get that opportunity. So my question is at what point should I abandon the stock and sell it outright, then go into another position?
Regards,
Jamie
Jamie,
There is one other exit strategy opportunity that should be considered in these scenarios … rolling-down. If the 20%/10% thresholds have been breached, we seek to “hit a double” in the 1st half of a monthly contract. Plan B is to roll-down latter in the contract.
Plan C is to sell the stock and we have 2 guidelines to consider when share price has declined:
1. Sell when the stock or ETF is significantly under-performing the overall market (S&P 500).
2. When share price has declined >7% from its price when the trade was initiated (7% guideline).
If we do decide to sell the underlying, we move to mitigate by using the cash to enter a new trade with the same expiration date.
Not all trades will be winning ones, but it is our mission to use our exit strategy arsenal to mitigate losses and enhance gains.
Alan