In challenging market environments, we favor in-the-money strikes for our covered call trades. The intrinsic-value component of our option premiums will provide additional downside protection and lower the breakeven price point (BE) below that of at-the-money and out-of-the-money strikes. But which ITM strike should we select? This article will explain the BCI approach to select such a strike using ETSY, a stock in our premium member stock report on 12/28/2020 (ETSY had a significant price decline after the recent earnings report which we all avoided, I hope).
ETSY bullish price chart on 12/28/2020
ETSY: Price Chart Showing Bullish Moving Average Signals
ETSY option-chain on 12/28/2020 for ITM strikes
ETST Option-Chain for the 1/29/2021 Expiration
- $170.00 strike: Bid price of $$24.35
- $175.00 strike: Bid price of $20.80
- $180.00 strike: Bid price of 17.85
Keys to ITM strike selection
First, we must define our initial time-value return goal range. Without that, we could never have a structured approach to strike selection. For me, it’s 2% – 4% per month for near-the-money strikes. This applies to both OTM, ATM and ITM strikes. Once we establish the ITM strikes that generate appropriate time-value returns based on our personal goals, we go to the next layer of evaluation:
- The more defensive we want to be, the closer to 2% we go
- A moderate defensive position would target a 3% initial time-value return
- A minimal defensive position would target a 4% initial time-value return
ETSY 1-month initial time-value calculations with the Ellman Calculator
ETSY Calculations with the Ellman Calculator
- All initial time-value returns meet the 2% – 4% stated goals
- The $170.00 strike offers the greatest downside protection of the initial time-value profit of 10.7%, with a BE of $166.08
- The $175.00 strike offers the moderate downside protection of the initial time-value profit of 8.1%, with a BE of $169.63
- The $180.00 strike offers the smallest (but still significant) downside protection of the initial time-value profit of 5.5%, with a BE of $172.58
Discussion
When selecting the best ITM covered call strike, we must first identify our initial time-value return goal range. Then we go to an option-chain and feed that information into the multiple tab of one of the BCI Calculators. The most appropriate strike will align with our stated goal and reflect the degree of protection we are seeking.
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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:
Hello Alan – I am new to options trading and would like to thank you personally for the wonderfully clear, educational, and helpful videos that you have posted on YouTube. I am sure you have heard this many times, but you have a straightforward, plain spoken clarity that is rare and I am grateful that you have sacrificed your time to help newcomers like myself understand the world of options trading.
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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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Hi Alan,
I had a question about bid-ask spreads.
I recall you want the spread to be $.30 for near the money options. What are the rule of thumbs for in the money and out of the money?
Second, many of the stocks that pass the screen have near the money option spreads greater than $0.30 and they never seem to get smaller. Should these be avoided?
Thanks.
Sincerely,
Todd
Todd,
The BCI guidelines for all strikes (ITM, ATM and OTM) is to favor open interest of 100 contracts or more and/or a bid-ask spread of $0.300 or less. This will mitigate scenarios when we need to buy back the option.
The best time to check the bid-ask spread is during normal trading hours. The BCI premium member reports will show a column (3rd column from right) that reflects the open interest (*OI) at the time the report was crafted. A “Y” means adequate open interest. We leave those that do not have adequate OI but pass all other rigorous screes (“N” in that column) for 2 reasons. First, the OI can change during the week. Second, we have members who use our reports for buying and selling stock without the option component. Our reports allow premium members to quickly identify option liquidity requirements.
Alan
Alan,
If I like a stock that has gaped up and I’m afraid of profit taking, can you suggest a way to still use the stock and protect against the price going back down? A few times I didn’t pull the trigger and missed out.
Thanks,
Dennis
Dennis,
If a stock gaps up as a result of positive news, perhaps an earnings report, I will view it as a bullish signal. We can wait a short period to see if profit-taking occurs but, overall, it’s another reason to consider this security and (for me) take a bullish stance.
To directly answer your question about how to manage a gapped-up stock if we are concerned that the stock price may go down, I can offer several offsets. Here are a few:
1. Sell in-the-money call strikes and deeper out-of-the-money put strikes to create additional downside protection.
2. Add a protective put to our covered call trades. This is known as the collar strategy.
3. Sell out-of-the-money cash-secured puts to enter a covered call trade. This is known as the PCP (put-call-put) strategy in the BCI community.
When deciding which strategy approach to take, we must factor in our personal risk-tolerance. It will not be the same for every investor but knowing our choices and selecting accordingly will allow us to sleep better at night.
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 06/04/21.
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
On the front page of the Weekly Stock Report, we now display the Top Performing ETFs, the Top SPDR Sector Funds, and the 4 single Inverse Index Funds. They are sorted using the 1-month performances from the Wednesday night ETF report and the prices from the weekend close
Best,
Barry and The Blue Collar Investor Team
barry@thebluecollarinvestor.com
Alan,
I am looking to use your weekly-10delta put strategy with QQQ today but the returns seem to be less than 3% annualized. Am I missing something?
Thanks,
Stan
Stan,
You may be looking at the 6/9 expirations. QQQ has 2 weekly expirations. The 6/11 (Friday) put expirations should annualize in the 5% – 7% range if entered on Monday for this strategy.
Alan
Hey Alan,
I have attempted to add below a screenshot this morning of AMN. If you can see it, the one day one minute chart has the MACD 9 day (red) crossing the 26 as I interpret it.
This is descending while above the candle sticks are ascending in the above chart. Should these not be in sinc?
Have I configured my charting incorrectly?
Cheers,
Clark
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Clark,
There can be a divergence between trend and momentum which is why we evaluate both in creating our technical charts. This will allow us to formulate a mosaic to determine if we have a bearish, bullish or mixed chart pattern.
Now, there is usually a correlation between price and MACD. It is difficult to read the enclosed chart but I created one based on our BCI parameters which reflects a direct relationship between price action and MACD (V-shaped pattern). As of today, we have a bullish chart pattern with AMN.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan
Hi Alan,
In many of your Ask Alan videos, you mention that we should be seeking a 2-4% monthly return when selecting a strike price. Is this the ROO or does it include any upside potential in share appreciation? Does the 2-4% range apply to ETFs like the QQQ or only to individual stocks?
Thanks,
Lucy
Lucy,
The 2% – 4% initial time-value return goal range is my personal range based on my risk-tolerance and strategy goals. This range may vary from investor-to-investor. For example, in my mother’s more conservative portfolio, I target 1% – 2%.
These stats are based on ROO only, without the upside potential component when using out-of-the-money strikes.
The time-value returns are directly related to the implied volatility of the underlying security (stock or ETF). Since individual stocks generally have higher IV than ETFs (there are exceptions), the 2% – 4% aligns more with stocks than ETFs.
Our premium member ETF and Blue Chip Reports have IV stats listed in the reports and the stock reports have beta (historical volatility) listed.
*** We will be adding IV stats to the stock reports starting this coming weekend.
Alan
Today’s Mad Hedge webinar:
Several of our members had difficulty logging-in. This presentation was recorded by the Mad Hedge folks and they will send all those who registered an email notification next week when it is available on their site.
Alan
Alan,
Morning, I tried to watch you on Max Hedge yesterday but I work remote and had to many of my day job meetings going on.
Do you have a recording or something similar on the repair lower stocks section or the concept in a video on the members site, I was trying to follow along but could not audio in so I missed it, or should I just wait until next week on max hedge?
next, when you set up your CC position, do you recommend after setting you 20% BTC orders, setting a trigger order (not sure if this can be done in Think or Swin) to sell the stock, STOP @ 7% below purchase price?
I think you will lose the 7% on a falling stock but recover about 3% on the BTC of the option or maybe more if in the last 2 weeks (at 10% BTC) for a net loss of around 3-4% but you have protected the downside and live to make another trade…
Let me know… thanks, Michael
Michael,
My responses:
1. Those who registered for my Mad Hedge webinar will receive a link to listen to the recording on their site, probably next week. I was an invited speaker to that event.
2. I strongly recommend setting the 20%/10% guideline BTC limit orders after entering a covered call trade. If and when those thresholds are reached and the short calls are closed, we can decide on next steps which may or may not be the sale of the stock. If share price declines by 7%, we can consider that a reasonable threshold to sell the stock. Otherwise, re-selling another option may be the better path.
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.
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