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Setting Up Your Portfolio Using the Ellman Calculator and the Premium Report

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:

Multiple tab of Ellman Calculator

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:

Initial 4-week return with a bullish outlook

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.

To learn more about our premium reports:

/membership.shtml

For a FREE copy of the Basic Ellman Calculator, email me @:

alan@thebluecollarinvestor.com

Include your name and “request Ellman Calculator”.

Market tone:

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.

Summary:

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 (alan@thebluecollarinvestor.com)

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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.

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33 Responses to “Setting Up Your Portfolio Using the Ellman Calculator and the Premium Report”

  1. Pam July 23, 2011 3:43 pm #

    Alan,

    Can you explain the calculations for EBAY (1.27 – .32 = .95). I just started watching the DVDs but haven’t gotten to the section on calculations. I’ve learned a lot so far.

    Pam

  2. admin July 23, 2011 5:46 pm #

    Pam,

    Since we purchased EBAY @ $33.32 and sold the $33 call, the strike is said to be “in-the-money” or lower than the market value of the stock. We are obligated to sell @ $33, thereby losing $0.32 per share (called intrinsic value). Since we generated $1.27 of call premium/share, we must deduct the $0.32 potential loss to determine our true initial premium profit:

    This results in an initial ROO of $0.95 per share, $95 per contract and $285 for the 3 contracts. This is explained in detail in the “advanced” disc of the DVD series and in both my current books.

    Alan

  3. Barry B July 24, 2011 2:35 am #

    Premium Members,

    The Weekly Stock Screen And Watch List report for 07-22-11 has been uploaded to the Premium Member website.

    Best,

    Barry

  4. admin July 24, 2011 4:59 am #

    PII:

    This stock has been on our premium watch list for 12 weeks. This week premium members will note that it is located in the “Passed All Screens” section.

    On July 21st the Board of Directors of PII approved a 2-for-1 stock split effective September 12, 2011. In addition, the company declared a regular quarterly $0.45 per share (pre-split) cash dividend payable on August 15th, 2011 for shareholders of record at the close of business on August 1, 2011.

    If you own 100 shares @ a cost basis of $120 per share prior to September 12th, you will own 200 shares @ a cost basis of $60 per share after September 12th. If the shares are purchased prior to August 2nd, you will also capture a $45 cash dividend per 100 shares.

    Alan

  5. admin July 24, 2011 9:01 am #

    Premium members:

    We are currently enhancing this week’s premium report so that it is sorted according to earnings reports dates. The stocks on the list remain the same. We will send you an email and post on this blog when it is uploaded to your premium site.

    Alan

  6. gary July 24, 2011 8:07 am #

    I’ve been a member for nearly a year, but time restraints have limited my fully understanding the program. My questions:
    Do all selections come from running list?
    Generally are bolded selections better?
    When position is established and moves to “failed current week” list, time for exit or wait it out?
    I understand the diversification and the no buy ER time but trying to get a better understanding of choosing positions. Thanks for the help.

    Gary

  7. admin July 24, 2011 8:55 am #

    Gary,

    YES, all selections come from the “running list” which represent the stocks that meet the predefined requirements of the BCI methodology. ALL of my personal selections come from this list.

    Bolded stocks indicate stocks that meet ALL the system requirements PLUS have ALL confirming technicals. They are the strongest stocks that week but the ranking can change week-to-week as stocks whipsaw in their normal trading patterns.

    If a stock moves to “failed current week” and you hold that equity, you do NOT automatically sell the stock and unwind your total position. That position is managed as set forth in my book on exit strategies. It is a red flag that we should pay attention to this stock and take action if needed, for example, if it meets the 20%/10% guidelines to buy back the option.

    I have produced two videos relating to using the premium report found on the information page of the premium site (lower left portion of the page):

    https://www.thebluecollarinvestor.com/membership.shtml

    Alan

  8. Barry B July 24, 2011 10:21 am #

    Premium Members:

    This week’s Weekly Stock Screen And Watch List has been revised and uploaded to The Blue Collar Investor Premium Member website and is available in the “Reports” section. Look for the report dated 07-22-11 REVA.

    Best,

    Barry

  9. Fran July 24, 2011 12:21 pm #

    Alan,

    Do you ever buy puts to protect your covered position? I have heard that this is a safer way to invest.

    Thanks.

    Fran

  10. admin July 24, 2011 4:31 pm #

    Fran,

    Incorporating protective puts into your covered call strategy will prevent a catastrophic loss from a sharp decline in share price. For example, if you buy a stock for $48 and sell the $50 call for $2, you have a 4% initial return and a $46 breakeven. If the stock price drops dramatically below $46 and you do not institute an exit strategy maneuver, a large loss could be realized.

    Now if you bought a protective put, let’s say the $45 @ $1, you now have the right to sell the stock for $45 no matter how low the price goes. That leaves a $1 initial profit or 2%. The breakeven is $47, with protection below $45 but not between $47 and $45 (although there may be some put premium value). As you can see, it gets a bit more complicated but it is a viable, conservative strategy that is appropriate for certain investors. I do not use protective puts but remain extremely diligent to institute an exit strategy when indicated. Since we avoid earnings reports, we only can get hurt from a “gap down” following unexpected bad news like corporate fraud, a CEO announcing retirement or something of that nature.

    Alan

  11. admin July 25, 2011 8:09 am #

    CPX:

    Recently reached an all-time price high after reporting strong 2nd quarter earnings. Revenues rose 11% and earnings surprised by 8%. The balance sheet shows debt (650M) higher than cash ($171M) but the cash position has risen by $44M in the last quarter. Analysts are projecting a bullish 26% growth projection. The stock is trading at a superlative PEG of 0.54. This stock has been on our premium watch list for 12 weeks, has an industry rank of “A” and a beta of 1.65.

    Alan

  12. Marty July 25, 2011 5:16 pm #

    Yikes…NFLX down $25 after hours. I see what you mean about earning reports. Glad I exited!

    Marty

  13. Pat July 26, 2011 8:15 am #

    With NFLX looking down about $25 in premarket is this a good time to get in at a discount? Any thoughts appreciated.

    Pat

  14. admin July 26, 2011 6:47 am #

    PII (follow-up to my comment #4),

    Recently reported an outstanding 2nd quarter earnings report where revenues rose 41% and earnings where 16% ahead of estimates. The last 4 quarters have averaged a 33% positive earnings surprise. The financial profile shows cash up $96M to $262M while debt was reduced by 50% to $100M.

    There is also a bullish growth projection of 17%. PII trades at a forward PE of 20x compared to the industry average of 24x. Our premium watch list shows an industry segment rank of “A” and a beta of 1.57 in addition to the dividend yield discussed in comment #4.

    Alan

  15. owenCPA July 26, 2011 11:30 am #

    Marty and Pat,

    Even a “good” earnings reort can cause a severe fall if it is considered “not good enough”. I didn’t lose a dime. Of course, I didn’t make a dime when Google rocketed up $70 a few weeks ago after it announced its earnings.

    What I did do with GOOG was wait until Monday afternoon (earnings were at 8:30AM on Friday morning) to jump back into options on it. I will give people the rest of today to “evaluate” and discuss NFLX and consider getting back in tomorrow or Thursday. There is another point to remember with NFLX. Monday the short interest was around 19% of the outstanding shares. There are a lot of shorts out there looking for a drop to buy it back. Whether, or not, today’s drop is sufficient remains to be seen, but that is a lot of pent up buying demand waiting in the wings.

  16. Steve July 26, 2011 1:31 pm #

    Alan,

    When you calculate the downside protection “of the initial option profit” do you divide the intrinsic value by the current stock price or the strike price? I apologize if this question has been previously asked.

    Thanks very much.

    Steve

  17. owenCPA July 26, 2011 1:43 pm #

    Steve,

    Sorry, your question is a bit confusing. To calculate the “downside protection” you subtract strike price from the current stock price. Example: I buy XYZ at $38 and sell the $35 call for $4. My “downside protection” is $3, the intrinsic value. My “profit” will be $1 and the ROO will be calculated by dividing the $1 by $35. We use the intrinsic value as a “buy-down” of the stock.

    The result is that we are getting $1 for a $35 investment, not $4 for a $38 invetment. Think of the intrinsic value as sort of a “down payment” on the option exercise, even if it never gets exercised.

    Be careful when you are doing your Schedule D for capital gains. If the option expires you will have a $3 short term capital gain.

  18. admin July 26, 2011 2:06 pm #

    Steve,

    As always, Owen is spot on in his response that the $4 premium is divided into $1 time value (our initial profit) and $3 intrinsic value (our protection OF THAT PROFIT). The breakeven would be $34. To calculate the percentage protection divide the $3 by the current value or $38:

    3/$38 = 7.9%

    If the current market value of $38 drops by 7.9% we are at the strike. What this all means is that our 2.9% initial profit ($1/$35) is guaranteed as long as the share price does not decline by more than 7.9% in the 1-month time frame.

    Thanks Owen for pointing out potential tax consequences if not trading in a sheltered account.

    Alan

  19. Allan July 27, 2011 8:06 am #

    Alan,

    Can the Schedule D of your Elite Calculator be used to calculate final results? I’m a new member and just started reading the user guide.

    Thank you.

    Allan

  20. owenCPA July 27, 2011 10:09 am #

    Allan,

    The Schedule D pages are only provided as a convenience to make your tax reporting easier. There are a many people, including accountants, who do not know how to report options trades when they are exercised. The Schedule D pages don’t calculate percentage gains or losses.

  21. admin July 27, 2011 11:00 am #

    Many thanks to Owen for developing the Schedule D for the calculator benefiting the BCI community. Although it will not calculate percentages it will calculate long and short-term capital gains (losses) in dollar amounts. Premium members can find a free version of the Elite Calculator in the “resources/downloads” section of the premium site.

    Alan

  22. admin July 27, 2011 12:58 pm #

    PM:

    For those willing to consider a global tobacco company, this may be a stock to consider for your watch list. On July 21st PM reported its third consecutive positive earnings surprise with revenues up 10.2% and earnings up 21%. Operating income rose 16.5%. There is also an 11% EPS growth projection.

    PM has been buying back shares to enhance share value…22.7M shares in this 2nd quarter and 378M since its March 2008 spin-off. It also pays a generious 3.6% dividend yield. PM trades at a reasonable PE of 15.2 x forward earnings.

    Alan

  23. Nelson July 27, 2011 5:43 pm #

    Re Comment #17, would it be a $3 or $4 short term capital gain? Thanks for this great blog. Always very helpful. Nelson

  24. Fred July 28, 2011 8:07 am #

    Most of the stocks on the running list have industry segment ranks of A or B but once in a while there is a C. How do you handle these? Favor only the As and Bs?

    Thanks as always.

    Fred

  25. owenCPA July 28, 2011 10:34 am #

    Nelson (#23),

    Sorry, my mistake. If the option is sold for a $4 premium, and it expires, you have a $4 short term capital gainn ot $3. It does not matter if the option was in the money, or out of the money, when it was sold.

    If the option was exercised, and your stock was called away, the option proceeds becomes part of the stock proceeds. Your gain on the STOCK would be $1. You sold the stock for $39 ($35 strike price plus $4 call premium) and you paid $38 for the stock. There would be no option transaction reported on Schedule D as a separate item. Also, if you held the stock for more than 1 year when it is sold, it is a long term gain. The option period is ignored.

  26. admin July 28, 2011 3:30 pm #

    Fred (# 24),

    Generally speaking I do favor stocks with an industry ranking of “A” or “B” but there may be something relating to an equity which will lead you to a stock with an industry segment “C’ ranking. For example, with MTZ on our current list you may feel that the “telecom industry” is about to take off and purchase this equity despite the “C” rank. Or you may like the aggressive 1.78 beta stat. One of the reasons we provide so much information in our weekly reports is that each investor may have his (her) own priorities. These are the securities that pass the BCI predefined screens. We give additional information and then you can make the best informed decision for YOU.

    Alan

  27. admin July 28, 2011 3:50 pm #

    QSII:

    Currently on our premium watch list, this stock today announced a 2-for-1 stock split effective October 27th. If you own 100 shares @ $90 prior to the split, you would own 200 shares @ $45 post-split. If you sold 1 x $90 call pre-split, that would change to 2 x $45 calls post-split. The increasing number of “legitimate” stock splits is another sign of an improving overall stock market. 2008 generated almost no splits at all.

    Alan

  28. Nelson July 28, 2011 4:11 pm #

    Thanks Owen. You’ve given some more valuable insight to another tax question with your reply. It’s appreciated. Tax treatment for non-sheltered funds keeps my head spinning (we won’t talk about calculating after-tax ROO). BTW, I discovered BCI almost a year ago, watched the videos, purchased and read the books, subscribed to the premium subscription, and am easing my toe into the water, all the while paying attention to Alan’s early advice to first paper trade, and then paper trade some more and, after that, do some paper trading. This blog is a trementdous resource for ordinary investors like me. Thanks again. Nelson

  29. owenCPA July 28, 2011 5:18 pm #

    We are glad to help, Nelson. The long held idea that you have to go to a stock broker to get broker is a myth. You can go just as broke by yourself with a little education.

    Ok, I got that a little wrong, but the idea is the same. Investing, and covered call writing, are not bizarre concepts that only Stephen Hawking can understand. When you learn the mechanics, and you begin to learn the how people like Alan select the stocks, you begin to see that any blue collar investor can do this, if they can get up the nerve.

    I mean think about it. If you enter a trade with an expected profit of $120, or 1.9% return, and you panic early, and get out with only a $60 profit, that is still a .98% return for a few weeks. Citibank will give you a .5% return for 52 weeks. Whoopdy-doo. Your .98% return for three weeks still comes out an annual rate of 17%.

    We (the blue collar investors) are not about trying to make a million dollars from $2,850 within a year, or two. We are about getting a better return than we can get from the banks, while still protecting our assets. And, when you can do it in a tax deferred account, or better a tax free (Roth IRA) account, your return is magnified by not having to share your success each year with the IRS, and whichever thieving state you live in.

    Good luck.

  30. admin July 28, 2011 7:01 pm #

    Premium Members:

    This week’s 6-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site and is available in the “resources/downloads” section. Look for the report dated 7-28-11.

    Please note that on page 6 of the report the Inverse ETFs are beginning to outperform as a result of the impending debt-ceiling crisis.

    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

  31. admin July 28, 2011 8:54 pm #

    Triumph Group (from our running list), (TGI) said it expects 2012 earnings of approximately $4.35 per share. The company’s previous guidance was earnings of $4.18 to $4.23 per share and the current consensus earnings estimate is $4.24 per share for the year ending March 31, 2012. This was reported after martket close today. Should see a bump in price tomorrow.

    Alan

  32. admin July 29, 2011 6:57 am #

    ATHN:

    Provides “cloud-based” business services for physicians, a topic our members touched upon in last week’s blog commentary. On July 21st ATHN reported a strong 2nd quarter earnings report with a 33% increase in revenues and net income expanding to $77.9M. Earnings were up $0.03 more than anticipated. Growth rates for 2011 and 2012 are now projected to be 49% and 55%. The recent surge in share price has moved valuations to a pricey PEG of 1.8. Our premium report shows an industry segment rank of “A” and a beta of 1.09.

    Alan

  33. admin July 29, 2011 9:02 pm #

    Premium members:

    A severe storm in the northeast has rendered my team without power this evening as we were researching for the premium report. Every effort will be made to publish the report as early as possible. This will depend on when power is restored. We’ll keep you informed.

    Alan

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