beginners corner

Rolling Up When Selling Puts To Buy A Stock At A Discount

Selling out-of-the-money cash-secured puts is a fantastic way to buy a stock at a discount. It can be used in lieu of setting limit orders. If exercised, our cost basis is the put strike minus the put premium generated. If unexercised, we get paid not to buy the stock! For example, if a stock is trading at $32.00 and we sell the 1-month $30.00 out-of-the-money put for $1.00, the following is true:

  • If exercised, our cost basis is $29.00, a 9.4% discount from the stock price when the put was sold
  • If unexercised, we generate a 1-month return of 3.4% ($1.00/$29.00).

A concern is that the underlying stock may increase in value and the put will not be exercised. This is not a tragic result because we are getting paid not to purchase the stock. Had we set a limit order, we would not have realized this profit.

 

Real-life example

On 3/7/2016, Five Below, Inc. (FIVE) was trading at $39.18. Let’s view the BCI Put Calculator to evaluate unexercised and exercised results:

selling cash-secured puts

FIVE Put Calculations

The calculator shows that, if unexercised, we will generate a 4.23%, 5-week return. If exercised, we purchase the stock at a cost basis of $35.50, a 9.39% discount from share price at the time the put was sold.

 

Puts have negative Deltas

If the price of FIVE rises, the put premium will decline because of its negative Delta and the chance of assignment declines. Can we make more money? YES. Part of the BCI methodology for put-selling is the 20%/10% guidelines where a put is bought back when the premium declines to 20% (in the first half of a contract) or 10% (in the latter part of a contract) of its original sale price. If share price accelerated to $42.00 in the first half of a contract and put price decreased to $0.30 (20% guideline), we would buy back that option putting ourselves in a position to role-up and generate more cash.

 

Strategy philosophy

Given the hypothetical that we want to either generate cash flow or purchase a specific stock (FIVE, in this case) at a discount, we can roll up to a strike closer “to-the-money” and generate another option credit. Our original strike was about $2.00 out-of-the-money so a similar strike if share price was now $42.00 would be the $40.00 strike. The premium would be expected to be somewhat lower than $1.50 as Theta is eroding time value. Let’s say we can generate $1.20 on such a put sale. It could be slightly more or less but the concept is the same. After the initial put sale of $1.50, we now generate an additional option credit of $0.90 ($1.20 – $0.30). This is an additional unexercised return of 2.3%. Our total 5-week unexercised return would then be 6.53%. Furthermore, since we are dealing with a put strike closer to-the-money, there is greater chance of exercise, one of our goals.

 

Cost basis if exercised after rolling up

The second put strike is $40.00 and the total net option credit is $2.40, resulting in an exercised cost basis of $37.60 ($40.00 – 2.40), a 10.5% discount from current market value of $42.00.

 

Discussion

When selling options, position management is critical to achieving the highest levels of profit. We use exit strategies to mitigate losses and enhance gains. In the example shown in this article, returns were enhanced by rolling up when the 20%/10% guidelines were realized.

 

Blue Hour webinar series update

The registration and information pages are almost ready for our Premium Members. I’m really looking forward to our new Blue Hour webinar series, free to Premium Members. The topic of our first presentation will be Portfolio Overwriting where we will discuss ways to enhance portfolio returns for long-term buy-and-hold portfolios using covered call writing. Barry Bergman, the BCI Director of Research, will be answering questions live as I host the webinar. I will also address certain selected questions sent to us from members who register. Premium Members who cannot view the presentation live will be able to access the seminar on the Premium Member site as it will be recorded and available to all Premium members, also for free. My team will be beta-testing the site this week and we’ll send out an email to all members when registration is open. This first webinar will be available only to Premium members. Future webinars will also be available to non-members for a modest charge. Member rates will increase on September 1st however all members registered prior to that date will be grandfathered into the current lower rates and will see no rate increase.

Next live event- Workshop

July 16, 2016

American Association of Individual Investors

Washington DC Chapter

Northern Virginia Community College

9 AM – 12:30 PM

Seminar information and registration link

 

Market tone

Global recovered most of their post-Brexit losses this week, aided by a promise to ease monetary policy by Bank of England Governor Mark Carney. Oil prices recovered as well. The Chicago Board Options Exchange Volatility Index (VIX) declined to 14.80 from 24.45 last week when it rose dramatically after the Brexit vote. This week’s reports and international news of importance:

  • Global market declines have been relatively modest in the wake of the UK vote to exit the European Union. Equities were down significantly in the days immediately after the vote, but have since recovered most of their losses, as it seems that the exit process will take even longer than markets first feared. The political fallout in the UK has been far more dramatic than the financial fallout
  • Bank of England Governor Mark Carney said on Thursday that the post-Brexit economic outlook has deteriorated and that some monetary easing will likely be required over the summer
  • The UK’s credit rating was cut by the major credit rating agencies after the Brexit result. Standard and Poor’s stripped the UK of its last remaining AAA rating, cutting its rating two notches to AA, while Moody’s put the UK on review for a downgrade, leaving its rating at Aa1. The European Union had its rating cut on the British decision to leave it. S&P cut the EU to AA from AA+
  • President Barack Obama signed a bill to create a federal financial oversight board for Puerto Rico on Thursday, just one day before the island was due to make $1.9 billion worth of debt payments

THE WEEK AHEAD

  • US markets are closed on Monday, July 4th, Independence Day
  • Service sector purchasing managers indices are released globally on Tuesday, July 5th
  • The US service sector PMI is released on Wednesday, July 6th
  • The minutes of the June FOMC meeting are released on Wednesday, July 6th
  • Bank of Japan Governor Kuroda speaks on Thursday , July 7th
  • The US employment report is released on Friday, July 8th

For the week, the S&P 500 rose by 3.22% for a year-to-date return of +2.89%.

Summary

IBD: Market in confirmed uptrend

GMI: 5/6- Sell signal since market close of June 27th (published prior to Friday’s close)

BCI: Cautiously bullish and now fully invested with 2/3 of my portfolio in individual stocks and 1/3 in ETFs. I have not sold any covered calls this contract month as a result of the Brexit vote and will wait for the July contract expirations to sell calls on the August contracts. I will adjust my positions using the next two Premium Stock and ETF Reports as/if needed to stay fully invested. After the initial market over-reaction, many professional traders elected to short stocks (sell shares they did not own by borrowing them from a broker) in anticipation of a steeper market decline post Brexit vote. They also expected a much longer recovery period. As a result many of these professional traders found themselves buying shares towards the end of the week to mitigate their losses as they “covered” their bearish positions.. This added to the market gains for the week.

 

WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US

The charts are demonstrating signs of a bullish short-term outlook. In the past six months the S&P 500 rose by 5%while the VIX declined by 29%, a bullish picture. Despite this bullish picture, I am still taking a cautious but active approach moving forward.
______________________________________________________
Wishing you the best in investing,

Alan ([email protected])

 

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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.

38 Responses to “Rolling Up When Selling Puts To Buy A Stock At A Discount”

  1. July 2, 2016 6:20 am #

    Allan,

    I am reading your exit strategies for covered calls book and have learned greatly.

    I have a question about a trade you made on page 41… the buy-back was $180.00-$440.00prenium = $260.00. When you sold the$72.50 call strike was there a premium and should not this be figured in % yield.

    I also believe a chart would be better with chaikin money flow included. Stock charts have this at no extra chg. I am currently looking for online discount brokers to set up account and one that has paper trading. I then will become a blue collar investor.

    Thanks,
    Scott

    • July 2, 2016 8:54 am #

      Scott,

      Page 41 of “Exit Strategies for Covered call Writing” shows an example of rolling out. The original profit generated from the near-month call or the cost basis of the original share purchase should NOT be calculated into our decision whether to roll the option or allow assignment. Whether to “roll” is the decision “on the table” at this point in time. When we are calculating our final returns and long and short-term capital gains and losses, that is another story but here we are looking to generate the highest returns at this point in time and deciding whether to “roll” or not to “roll”.

      Adding other technical parameters to those of the BCI methodology and changing one or more is up to the individual investor. If members have favorites other than the four I use, I have no issues adjusting or adding to the technical parameters.

      Alan

  2. July 2, 2016 6:33 am #

    Mr. Ellman,

    As I stated in my prior e-mail, I am trying to understand as much about what you wrote in “Complete Encyclopedia for Covered Call Writing.”

    During my recent review of IBD’s Top 50 against the first two steps of the process explained in the book, a couple of questions rose. I am hoping you will explain them to me.

    1. On several of the stocks I noticed that the MACD Histogram showed negative results on the daily chart but was positive in the weekly. This was true even if the entire month shows below zero. Would you please explain?

    2. Chart priority – when creating the charts, I have noticed that not all of the results point in the same direction (good candidate or not). Is there a priority amongst the various overlays and indicators? Is there a weighing of those same tools?

    Thank you,

    Larry E
    AAII Member, St. Louis, MO

    • July 2, 2016 1:54 pm #

      Larry,

      The reason I view daily charts is that we are undertaking 1-month obligations as opposed to much longer-term buy-and-hold scenarios when weekly charts may be favored. It is also the reason I prefer exponential moving averages to simple moving averages as we get quicker signals for share price movements.

      I view technical analysis as a mosaic of multiple parameters which creates a picture regarding bullishness or bearishness. No one parameter on its own is something to hang our hats on but all together we have a valuable selection tool that we use along with fundamental analysis and common sense principles like minimum trading volume. If I had to choose which technical parameter I value most, I would say the exponential moving averages but I would never, ever select a stock based only on moving averages. Along those same lines, I would never select a stock solely based on all technical parameters as the BCI methodology uses a 3-pronged screening process as I described above.

      Alan

  3. July 2, 2016 7:11 am #

    Alan,

    Thank you so much for taking the time to help me. I signed up for your service yesterday and reviewed the 6/27 weekly stock screen and watch list. I have a Think or Swim Paper trade account. After I got home from work today I placed a market order for 8 stocks in 8 different sectors and sold calls on each of them. I was able to buy the stock and sell the option with one trade to help reduce the (future) commissions. This was the easiest way but I’m not sure if it is the best way. Do you recommend buying the stock at market and then immediately sell the call with a limit order or bundle the trade as I did. I know you talk about using limit orders for selling calls, however I was not sure if that was only during the following months (if there is no earning report).

    Again, Thanks so much for taking the time to help me.

    I’m looking forward to watching these 8 positions and hope to start actually trading the BCI system soon.

    Nelson

    • July 2, 2016 7:55 pm #

      Nelson,

      The best way to learn is by “legging-in” which means buy the stock first and then sell the option. The reason is that frequently we will be applying only one leg of the two-step trade as in rolling options or selling a stock when the option expired worthless.

      It is true that by combining both steps into one trade as many brokerages allow now usually decreases trading commissions but also takes away our leverage of the “Show or Fill Rule” I discuss in my books and DVDs.

      For more details on the one-step trade known as buy-write combination forms, see pages 219 – 223 of the “Complete Encyclopedia…” classic version.

      I would start with legging-in.

      Alan

  4. July 2, 2016 8:03 am #

    Alan,

    So in my panic state I did something that I probably should not have. I rolled down ACIA from 40 to 35 but now it’s back up to 41.11. I should have tried for a double.

    My original numbers were ACIA 100 shares bought for $40.64 Option price was $2.65 strike was 40 to 5% d/p 1.6%. My roll down brought me 35 strike 4% roo $1.35 option

    The BTC is currently 6.60- I’m so confused what move I should make? roll up- MCUW or do nothing! I really want to get this!

    I’m not great at math but I feel with a lot of practice I should be able to master this.

    Thanks,
    Jill

    • July 3, 2016 8:34 am #

      Jill,

      It took me years to figure all this out and develop the BCI methodology. It will take you months. You’re getting there. Let’s first look at the overall math:

      After the roll down, you are obligated to sell at $35, guaranteeing a share loss of $5.64 ($40.64 – $35). Your option credits net to $4 (assuming the $1.35 was a “net” number). This means you will have a 1-month loss of $1.64 per share with protection down to $35 (share price can decline to $35 and your loss will be no more than $1.64 per share).

      Now, let’s discuss the exit strategy used:

      This is a classic “hitting a double” scenario:

      • Share decline occurred early in the contract
      • Decline was due to overall market decline (hello Brexit), not related specifically to the stock

      You did the right thing by buying back the option upon share decline meeting the 20%/10% guidelines (I assume)…nice going! That’s when we needed a little patience to give the stock price a chance to rebound…a few days to a week. If it didn’t, we can always roll down mid-contract and generate some time value premium and downside protection.

      I also did the same thing so many times in the past before I realized the value of patience given the above two parameters.

      This is a great learning lesson for future trades.

      Alan

      • July 4, 2016 6:12 pm #

        Alan,

        Thanks for the quick reply. I think it’s great that you respond personally with your very busy schedule, it make me feel like we are all a big team and you are a great coach!

        So after I wrote this I made another move because of fear of losing the stock for 35. I am having a hard time seeing the big picture when I get nervous.

        So this is what I did-

        I bought back the 35 call for 6.00 p/s and sold the 40 call for $2.45

        This was the income:

        $70 for the 1st call
        $135 2nd call
        $245 3rd call

        MINUS BTC of

        $57 for the first call
        $600 for the 2nd

        So now with the last I have a $2.07 loss? but I don’t have to sell the stock at 35 now- this is the part I don’t know how to add back in?

        Thanks again for your time,

        Jill

        • July 4, 2016 6:21 pm #

          Jill,

          You’re being way too generous to your broker with all these trading commissions. Before we look at the math, it is important to understand that early assignment is quite rare especially when there is no dividend to consider. If that incredibly rare scenario of early exercise (with no ex-dividend date) does transpire, we can always buy back the shares that day and boom…we still own the stock. It will actually be cheaper for us because we will not have spent the time value component of the option premium to close the short call.

          Now the math: The loss is a bit more than $2.07. It’s a debit of $2.07 on the option side but we are also locking in a loss of $1.11 on the stock side for a net debit of $3.18. Sometimes less is more.

          Your determination to learn this is very impressive.

          Alan

  5. July 2, 2016 8:12 am #

    Alan,

    I bought volumes 1 & 2 of your Complete Encyclopedia a few months ago. It is indeed complete, but overwhelming. I am trying to figure out how much I need to know to trade successfully.
    I assume that the membership would eliminate the need for technical & fundamental analysis.

    Rich

    • July 3, 2016 11:36 am #

      Rich,

      There are many perks to premium membership and, absolutely, the weekly stock and ETF Reports will eliminate all need for security screening. This does include fundamental and technical analysis as well as the “common sense” screens like earnings reports and minimum trading volume.

      Alan

  6. July 2, 2016 8:52 am #

    I recently started looking into selling closed calls based on an offhand remark from an investment advisor I talked to. I had always associated options trading with risk, but have come to understand that there is a place for this particular type of options trading for the conservative investor. Is this the best kept secret in all investing? Or perhaps I was just uninformed.

    In any case, the first book I purchased on the subject was terrible – just totally repetitive, meandering, and disorganized. I had almost despaired of getting any good advice in book form, but I decided to give your book, Complete Encyclopedia for Covered Call Writing, a chance. What a difference! So far, I find your book well-organized and informative. I plan to study it thoroughly and really learn all the math and analysis before selling another covered call (although, to tell the truth, I have been doing reasonably okay doing it just “seat of the pants”). But I think with your help this strategy will really work well for me. Many thanks for writing such a clear and complete book and for making the calculator available.

    Leslie

    • July 3, 2016 11:43 am #

      Leslie,

      Thanks for your generous comments and welcome to the BCI community where we learn from each other. Let us know how you’re progressing

      Alan

    • July 4, 2016 2:10 am #

      Leslie,

      I enjoyed your post because I first learned covered call writing the same way you did: seat of my pants :)! I figured, how complicated can renting my stocks be?

      Turns out it isn’t complicated. But it is nuanced. And worth every minute you spend reading Alan’s Encyclopedia. Mine has a dozen dog eared pages. I re-read them often!

      And to your question: covered calls are no secret.

      In today’s zero rate environment articles about them abound. I can not speak for you but the over whelming balance of solicitations I get are about income. That is code for a service selling options. It is all the rage!

      At least Alan was “Country before Country was Cool” :). – Jay

  7. July 2, 2016 10:31 pm #

    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 07/01/16.

    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

    Best,

    Barry and The BCI Team

  8. July 3, 2016 10:05 am #

    Alan,

    I noticed the top etf on your last report is gdxj. I’m curious why we can still get 3% by selling the 46 covered call with only 2 weeks left to expiration?

    Thanks,
    Anthony

    • July 3, 2016 12:01 pm #

      Anthony,

      The answer to your question resides on page 7 of the latest ETF Report where we begin listing the implied volatilities of the eligible ETFs. Notice that GDXJ has an IV of 52.14 while the S&P 500 shows an IV of 20.56. Our premiums are directly related to the IV of the underlying securities. Your observation of the 3%, 2-week return is accurate but we must also keep in mind that the risk of share depreciation is also higher. That’s the trade-off. Now, the gold ETFs have been making a bundle of money for our members the last few months but that risk is always there. So we must measure our personal risk tolerance against this back drop and then make our decisions.

      Alan

  9. July 4, 2016 1:53 am #

    You covered (pardon the pun) what happens when a stock price gaps down.

    How about what do you do when a stock gaps up like 20% that happened to HOG Friday on take over rumors.

    William

    • July 4, 2016 7:20 am #

      William,

      When share price gaps up, we look to close the entire position when the time value component of the premium approaches zero. For example, had we sold the $50 call when share price was $48 for a premium credit of $1.50 and then price gapped up to $60, the cost to close would be about $10.10…$10 in intrinsic value and $0.10 in time value (maybe less). Once to option “cap” is removed, the share value is worth $60, not the original strike price of $50 so we have a stock price credit of $10 and an option debit of $10.10…net-net a cost-to-close of $0.10 per share. After closing the short option position and selling the stock, the cash can be used to initiate another income stream in the same month with a different covered call position. This is detailed in both “Encyclopedias…”:

      Classic: pages 264 – 271

      Volume 2: pages 243 – 252

      Alan

  10. July 4, 2016 6:06 pm #

    Alan,

    When doing a MCUW can you unwind from a stock and replace it with the same stock if it’s still paying a good return?

    Thanks,
    Jill

    • July 5, 2016 7:55 am #

      Jill,

      Rolling up in the same contract month is something I avoid especially when the gap-up is substantial. The reason is that we are now depending on a stock price to continue to accelerate in value after having a large movement up. Although possible, there is also the possibility of profit-taking and therein lies the risk. So I take my max profit and the newly acquired cash from the stock sale and use it to start a new covered call position with a different underlying. This will allow us to generate a second income stream in the same month with the same cash. Unless we are in a strong bull market environment, that second position is in-the-money to protect profits as there is less time remaining in the contract for exit strategy execution. Also, our time value goals for position#2 should be in the 1-2% range.

      Alan

  11. July 5, 2016 1:18 pm #

    Alan,

    I discovered the Blue Collar Investor a little over 2 years ago and since then have read every article and watched every video when they have arrived here in the U.K. on Sundays. Thanks very much for these highly informative and educational pieces.

    I bought the encylopeadia of covered call writing and have read the entire book.

    I now have a reasonable knowledge and understanding of all the key elements.

    My next step is to take this forward, however I keep running in to problems here in England which you will not have to deal with in the U.S.

    Here in the U.K. we have tax free accounts called I.S.A’s, I have now found out that we cannot keep foreign currency in I.S.A’s and that each time a U.S. stock is sold the resulting dollar credit has to be converted back to sterling, some of the currency transaction fees brokers have here are
    horrendous (as much as 3%).

    I am not aware of any way around this problem, you must have premium members in the U.K, have any of them made it known to you a way around the problem?

    I then thought that I could do this within a pension plan, but we have to put the money with a trustee company and those I have contacted say they would not allow me to trade coverd calls with a broker and in addition their fees are horrendous.

    Set up fees of £420 ($550), annual fees of £300 ($390) and fees of £300 ($390)
    every time I want to draw some of my own money!

    I have spent considerable time researching I.S.A.’s and pensions in the U.K. and cannot see a way forward with either of these.

    Without any contact currently with others in the U.K. following your startegies the only way may be to do this would seem to be outside of a tax free wrapper in the U.K. and subsequently pay tax on the profits.

    I appreciate you are unlikely to be able to help me in any way whatsoever,
    but if you do have any knowledge or information it would be most welcome.

    I am holding off taking out a premium membership until I can figure a way forward as all my cash is tied up in I.S.A.’s and pension funds.

    Regards,

    Alex

    • July 5, 2016 4:29 pm #

      Alex,

      So you’re the one who caused all that “Brexit” trouble in US markets last week. Our markets rebounded so all is forgiven.

      I am not familiar with UK tax issues but I do know that we have several members from the UK who trade covered calls on US exchanges. If you don’t have a tax advisor to discuss these matters perhaps contacting one of the major brokerages which allow international clients to trade on US exchanges. They may be able to add some color to this matter:

      For establishing accounts outside the US, look into the following:

       Charles Schwab
       OptionsHouse
       Options Express
       Interactive Brokers

      For contact information, click on the “Free Resources” link on the top black bar of this and all web pages.

      Alan

    • July 5, 2016 8:14 pm #

      Alex,

      As we do here I know you vote in private in England so I will not ask you how you voted on Brexit :). But what is your sense of the popular sentiment there now? Joy? Remorse? Indifference?

      I also can not help with your tax questions but enjoyed thoroughly your fine post describing the hurdles you face in the UK with covered call transactions. I had a colleague my age from the U.K. before I retired. We used to discuss the differences between retirement accounts and medical insurance in our two countries.

      For all the heritage we share our accountants sure fell from different trees :).

      I can vouch for both Options House and Schwab if you do look into a US – centric broker. I have moved all my business to Options House because of superior trade execution and low commissions. But Schwab may be more experienced internationally.

      And whichever side of the pond we are on it is always best to sell options in tax deferred/sheltered accounts. – Jay

  12. July 6, 2016 5:38 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.

    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

  13. July 6, 2016 6:40 pm #

    Yes I confess it was me causing those Brexit problems, I took an active part in the campaign, indeed I have been campaigning for it for 22 years!

    I have already contacted 3 of the brokers you recommend, if Interactive Brokers allowed I.S.A’s to be held with them it would be fine as their currency fees are miniscule, I have
    even double checked with them today directly.

    I certainly do not see a way to do this in the U.K. economically within a tax free wrapper, this just means it will take me longer to get organised and do this outside of one.

    Alex

  14. July 7, 2016 8:22 am #

    Alan,

    I hope you’re having a great summer.

    I’m reading your book (Stock Investing for Students) again (Repetition is the mother of learning), and I have another question maybe you could help me with:

    What’s the game plan once one reaches that 1.8 mil?

    Do we live off of the dividends and continue to invest the interest in more stocks? Or is it vice versus? How does one live off of this nest egg, while continuing to grow it, while not having to work a day job?

    Thanks in advance for your time.

    Best,
    Ryan

    • July 7, 2016 12:02 pm #

      Ryan,

      Now there’s a good problem to have…what to do with $1.8 million! Many financial advisors will tell you to move into bonds but I have a slightly different take. As we approach the age of 60, we are still long-term investors because life expectancy is now into the 80s and maybe even the 90s. There is no specific amount of money to set aside as it depends on our life style but we must have a certain amount of cash readily available for quality-of-life needs I(money markets, short-term CDs, savings accounts etc.). We can quantify that amount based on the last few years of expenditures with any adjustments we anticipate. The remaining cash should continue to work for us in the form of dividends and share appreciation as we begin to incorporate more bonds into our portfolio. As we get older the bond presence (look to low expense ratio bond funds…Vanguard has several good ones) should increase but at age 58 – 60, I believe stocks should still dominate whether in the form of individual securities or mutual funds.

      Without the plan and starting at a young age allowing for the power of compounding most of us would never be in a position to consider retiring at this young age and financially secure.

      Keep up the great work.

      Alan

    • July 7, 2016 5:53 pm #

      Ryan,

      First of all congrats on your investing smarts. What I tell my retired friends is put their first million in $700K SPY and $300K in TLT. Then sell covered calls each month to generate 1% OTM or $10,000 cash flow.

      If they can not live on $10K a month cash flow they never should have retired :). – Jay

  15. July 8, 2016 1:25 am #

    Thanks so much for the great info! It will be a great problem to have. Goals!

    Forgive me, as I’m still a bit dense when it comes to this, and I’m still trying to conceptualize this in really broad simplistic concepts.

    Would it be safe to say that once our ideal retired candidate reaches his 1.8, he would then sell off a specific amount of stock for cash income every year (say 100k is the desired amount) and let the remaining stocks continue to grow?

    Or would he pull out only a specific amount of dividends for the required income?

    How does he live off this pile of money, using it for income, without affecting its growth?

    Thanks again Alan.

    -Ryan

    • July 8, 2016 5:35 am #

      Ryan,

      I will highlight one approach to this great “problem” Let’s do the math. First we must determine how much income the $1.8 million will continue to generate even with more conservative investments (more bonds, CDs etc.). Let’s say 5% or $90k per year. Then add in other income sources like social security when age 66 is reached, 401Ks, pensions etc. Once that figure is established, we estimate our annual needs to see if there is a difference. If there is we can sell losing positions first (if any) to get tax credits to make up the difference. If we do need to sell shares, the 5% will result in slightly less than $90k each year so more shares will need to be sold each year but what a cushion we have to begin our retirement journey.

      Alan

      • July 8, 2016 10:32 am #

        Alan,

        As always I really appreciate your swift response. You really are helping so many people to achieve better financial futures. I can assure you that when I have children, they will be learning the guidelines in your book.

        Have a wonderful Friday and weekend.

        Thanks again,
        Ryan

  16. July 8, 2016 3:34 am #

    Alan, I have some more things to ask you which I know are a little late for this article but are nonetheless quite important.

    – First what I need to know, is if I am wanting just 5 stocks for trading CC’s, then how many stocks do I need to select from the running list to actually get this?(would you say like at least 10,15 or so, before they are narrowed down from our priorities?)

    – Is our goal to making this 2-4%/month (with stocks) before or after commissions are taken into account?

    – What % in price either side of a strike price could you now call it to be ITM or OTM?(this has certainly confused me)

    – Do I need to keep checking the options chain for my trades to see that there is enough O.I, and a 0.30c B/A spread?,- and if so then how often should I keep checking these?

    – And last when using a new stock in the 2nd half of the contract you say in your book to sell ITM strikes, but if stock technicals are mixed then would I then need to sell even further ITM, or not use the stock at all, if I can’t get enough return for this strike?

    Your help with all this would be very much appreciated. Thanks

    • July 8, 2016 5:55 am #

      Mike,

      As you get more familiar with our premium stock lists, you will establish certain criteria for the stock selection. As an example, many members look to stocks in bold (strongest technical as of Friday close) along with stocks in industries ranked “A” or “B” Others may factor in stocks that also offer dividends or beta statistics. Final decisions are based on premium return and proper diversification. To end up with 5 candidates, we’ll probably look at about 10 to start.

      Commissions are not factored into my calculations but using the right online discount broker will make the percentages only decimal points lower especially when trading multiple contracts. The 2-4% is based on bid price/price-per-share.

      Good question regarding the “moneyness” of a strike. This is a gray area. I refer to strikes very slightly away from current market value as “near-the-money” When making investment decisions, we set our time value goals and then go ITM or OTM based on overall market assessment, chart technical and personal risk tolerance. For example, the more market concern we have, the deeper in the money options we would select. The amount of protection or upside potential the strike offers is more important than a specific definition as to when near-the-money becomes ITM or OTM.

      Option chain liquidity only needs to be researched when entering trades. 20%/10% limit orders can be set up after entering trades to partially automate the buy-back process when those opportunities arise.

      Mid-contract, our goals are reduced to 1-2% for the remainder of the contract favoring ITM strikes when possible. In strong bull markets, opting for OTM strikes is reasonable.

      Alan

  17. July 8, 2016 6:44 am #

    Premium members,

    Registration for the July 28th Blue Hour webinar is now open to Premium Members only. This event is free to members. Once you are registered, you will receive instructions regarding how to attend this event and will be given an opportunity to submit a question.

    To register, login to the member’s site and scroll down on the left side below the store discount link. Then click on the Blue Hour sign-up link and fill out the short registration form. For members who cannot attend the event live, my team will be recording the webinar and it will be posted on the member site the following week.

    The BCI team and I are looking forward to providing this new educational tool to our members and happy to make this a free resource for our loyal members. On September 1st, there will be a rate increase for new members but you will be grandfathered into the current lower rates as long as membership remains uninterrupted.

    Thank you for your loyal support over the years.

    Alan and the BCI team

  18. July 10, 2016 2:10 am #

    Alan, thanks for the responses, but I will need to go over my Qu’s 3 and 5 again.
    For the 3rd one, I know about the more ITM or OTM a strike is from the current price then the more downside protection/upside potential there is, but it is the strike that rests just a little way from the price, where I am referring to how you would categorize whether the strike is an ATM(or near money) strike or more likely an ITM, or OTM strike.
    An example on a recent stock I used was AMJ.
    If I want to sell the $32C with price at $32.10, well I guess you would have it classified as an ATM strike. But what if the price instead was say $32.20, is it ITM yet?, or if it was higher – $32.30, or $32.40 even?
    Isn’t there a rule where if the price is maybe at least 1% or some other percentage away from the strike, then it is more than likely now deemed an ITM(or OTM) strike?

    – That too brings me to the Qu.5 where you stated, on a ‘new stock in the 2nd half of the contract you sell ITM strikes’.
    But how do I know I am selling an ITM strike and not an ATM strike instead, like for the above examples if the price was sitting at $32.20?
    You wouldn’t say a better term would be something like:-
    “On any new stock in the 2nd half of the contract under normal market conditions with positive chart technicals I will sell ITM strikes at no less than 2% under current price” ? (or some other percentage?)

    – And also for any new stock in the 2nd half of the contract, then couldn’t I pick an ITM strike whether a method like this:-
    Sell new call options 2% ITM, if market-tone mixed then go 2% extra ITM, if chart technicals mixed then go another 1% ITM.
    So then if % total in these conditions = 5%, then a stock worth $20 could have a $19 strike price?
    Wouldn’t this be a valid method I could try for estimating the best strikes to use?
    But if you say the only way is to use a strike based on a 1-2% goal, and my minimum goal would be 2%, well it would seem I should again use a percentage eliminating method from any added “mixed market tone/mixed chart technicals” as described by me above. So in this case starting at a minimum 2% goal, but then subtracting say 0.50% off it at a time from market or chart concerns.

    Those had been the issues I have had in my head recently in regards to selecting the appropriate strike. Some of that are just other method approaches which I thought may work.
    I hope you aren’t too busy to help again.

    Thanks. Mike

    • July 10, 2016 10:47 am #

      Mike,

      I admire your tenacity and determination to master these concepts. The distinction between ATM and slightly ITM or slightly OTM is a gray area. I have never seen nor have I, myself, dedicated a specific percentage from current market value to define these terms. Here’s why a specific percentage is not critical:

      When we sell an ITM call, we are looking for a certain percentage of time value profit + a certain percentage of intrinsic value downside protection. These amounts will vary from investor to investor. My goal for initial returns is 2-4% per month. In my mother’s account it’s 1-2%. Mid-contract, I reduce my goals in half. The strikes we select are based on our goals, not on a specific definition of a term. Let me draw what I hope is a meaningful analogy:

      If, in the past year, a stock has an average price (ATM) of $50, and today the price is $50.10. Is today’s price above average (OTM) or average (ATM)? What about $50.20? Let’s say we applied a 1% rule (not unreasonable). Then above average would be $50.50. If we accepted that then $50.49 would only be average.

      In my view (I always tell members to feel free to adjust to meet their own trading styles) the best way to take advantage of the concepts of OTM, ATM and ITM is to set goals for ROO (time value return on option) plus the amount of upside or downside we are seeking.

      That said, for my second position when administering the MCU exit strategy in normal market conditions, I set my goal for 1-2% for the second half of the contract and then go as deep ITM as possible to achieve this goal. As I said previously, in a strong bull market I will often use OTM strikes for my second positions.

      Thanks for sharing your thoughts on these very important concepts.

      Alan

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