It’s been a while since we talked math. What’s with all the frowns? Mastering and understanding the calculations (my calculator will do all the work!) will enhance our bottom lines…more cash in our pockets. With that in mind, let’s set up a hypothetical portfolio of 5 securities with a cash available reserve of $50,000.
Since our system requires cash, stock and industry diversification, we will look to purchase 5 securities in 5 different industries and allocate approximately $10k per equity. I turned to our premium watch list for eligible securities and (randomly, these are not recommendations) selected 4 stocks and 1 exchange-traded fund from our premium reports. Here are the securities with industry and price:
- PVH- apparel: $74.63
- GSM- Metals: $24.50
- HAL- Energy: $56.97
- EBAY- Retail: $33.32
- ICF- Real Estate ETF: $76.28
I compute the number of shares to purchase by first dividing $50k by 5 (stocks) and allocating approximately $10k per equity. We must also be sure to leave a small balance for possible exit strategy execution. We then divide the price-per-share into $10k and round to the nearest “100” (there are 100 shares per contract). This is called cash allocation. Our portfolio will look something like this:
- PVH: 100 shares
- GSM: 400 shares
- HAL: 200 shares
- EBAY: 300 shares
- ICF: 100 shares
This represents a total investment of $46,291 leaving about $3700 for possible exit strategy executions.
Next we turn to our options chains and look to the nearest strikes prices, both in, at, and out-of-the-money. We enter the information in the “multiple tab” of the Ellman Calculator”. Here are the statistics entered into the calculator as of 12PM EST on Friday July 22nd:
The beauty of this calculator is that it will assist us in making our investment decisions based on our market assessments and chart technicals. If we are bullish on the stock and overall market, we look to garner the highest ROO (return on our option) and upside potential (out-of-the-money strikes). If we are bearish or concerned in any way, we look to get the additional downside protection of an in-the-money strike. In the chart above, I highlighted in yellow the choices we would favor if we were bearish. We can generate a 2%, 1-month return with some excellent downside protection.
I also highlighted in green, some bullish choices we would consider where the return and potential return is greater but with little or no downside protection of the initial option profit (time value of the premium).
If we wanted to generate the greatest initial return, we would look to the selections where I placed the red arrows. The chart below demonstrates such initial returns:
Note that for EBAY the strike was slightly in-the-money so we deduct the intrinsic value from the premium before calculating our initial option return.
Once we have selected our stocks and sold our options and placed them in our portfolio manager (organized lists), we begin the process of managing these positions for possible exit strategy executions. This will not take a lot of our time. There is a learning curve to covered call writing but once mastered, it becomes second nature and a great way to invest and become financially independent for many Blue Collar Investors.
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As I write this paragraph the President and Speaker are going at it regarding the debt ceiling, taxes and revenues. What transpires this weekend should have a major impact on the market next week. Stay tuned. This week’s economic reports:
- The Conference Board’s Index of leading economic indicators rose 0.3% in June, an encouraging signal that April’s (-) 0.3% reading was an aberration.
- Construction of new US homes increased 14.6% in June, greater than analysts’ expectations. Housing starts are up 16.7% from a year ago.
- Sales of existing homes fell 0.8% in June, the third straight monthly decline.
- Compared to a year ago the median price of homes rose by 0.8%
For the week, the S&P 500 was up 2.2% for a year-to-date return of 8.1% including dividends.
IBD: Confirmed uptrend
BCI: Until the debt ceiling issue is resolved I am taking a neutral position in the market, not adding additional capital and selling only in-the-money strikes. If this issue is resolved, I will take a bullish stance and begin incorporating out-of-the-money strikes. I can’t imagine this not getting resolved in a positive way but it is also inconceivable that the issue remains unresolved this close to the August 2nd deadline. Earnings reports have been outstanding and the economy continues to improve albeit at a snails pace. A personal message to our Congressmen (women): Get to work and do your jobs!
Wishing you the best in investing,
Alan ([email protected])