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Short-Term Trades with High Returns: Evaluating a Real-Life Example

Covered call writing is a conservative strategy for cautious investors. We want the higher than risk-free returns with the least amount of risk. One question that does come up in this regard is why not enter a short-term trade that offers impressive returns? To get an understanding if this is a beneficial approach there is nothing like a real-life example to dissect every aspect of such a trade. I will be using Sarepta Therapeutics Inc. (NASDAQ: SRPT) to highlight the key aspects of this article.

 

SRPT: 3-day trade from June 6, 2016 – June 9, 2016

  • 6/6/2016: Buy SRPT at $15.40
  • 6/6/2016: Sell $16.00 call at $1.90
  • 6/9/2016: Plan to close trade prior to expiration

Ellman Calculator

covered call writing calculations

SRPT: 3-day calculations

The multiple tab of the Ellman Calculator shows a 3-day initial return of 12.3% with the possibility of an additional 3.9% if share price moves up to the $16.00 strike by expiration. This annualizes to between 1000% – 2000%. I don’t know about you but I’m beginning to get nervous!

 

Here’s what we know without even 1 second of research

1- We know that options returns of this magnitude and time frame are based on an underlying security with massive implied volatility. This means that the market is anticipating huge price movement in either direction. Frequently, this will results in gap-ups or gap-downs…sudden and dramatic price movement. Is this what we want as conservative investors where capital preservation is a top priority? (hint…no). To confirm this, let’s have a look at a 1-year price chart for SRPT showing two gap-downs of over 50% each time:

 

volatile stocks and covered call writing

SRPT: 1-year chart

 

Neither gap-down was related to an earnings report but rather the nature of the underlying security.

2- We know that there is a likelihood of some event expected that could rock the share price in either direction. We have eliminated earnings reports as that event due to our standard screening process.

 

Checking the news: www.finviz.com

Sure enough, there was expectation of a news announcement by the FDA regarding a muscular dystrophy drug being developed by SRPT:

FDA drug approvals and stock options

SRPT: News in June, 2016

The risk is now explained and the question is should we be enticed? (hint…still no).

 

So what happened?

covered call writing short-term risk

SRPT Chart Showing 3-day Performance

Clearly the trade had a happy ending with a 3-day return of 16.2% (12.3% + 3.9%) as share price moved from near$16.00 to near $21.00 (brown field). Is our conclusion then that short-term volatile trades should be a recurring aspect of our trading strategies (hint…well you know).

 

For Whom and when should such trades be considered?

Trades which offer huge short-term potential profits are highly risky trades which make a lot of money or result in extensive losses. They are for traders with high risk-tolerance looking to hit it big. Covered call writing is on the other end of the spectrum, most appropriate for conservative investors who stress capital preservation. Should such a high risk/reward trade be entered, a covered call will limit the upside but not the downside. In the highlighted trade, $2.50 ($1.90 + $0.60) was generated but it could have been more than $5.00 per share had the call not been written. The major reason for not entering such a trade is the downside risk had the news been disappointing.

 

Discussion

Short-term trades offering high returns are most appropriate for investors looking to hit a grand slam homerun with the understanding that substantial losses are possible. With that in mind, each investor must decide which strategy is most beneficial based on personal trading style.

 

Upcoming live events

1- February 27 and 28th, 2017

Stock Trader’s Expo

Marriott Marquis Hotel, NYC

1:30 PM ET (Monday)

1:30 ET (Tuesday)- This presentation will be webcast by The Money Show

Exhibit Hall Booth 208 (February 26th – 28th) … come say hi to the BCI team

2- March 21st and 22nd, 2017

Two live Florida events (Fort Lauderdale -22nd and Delray Beach- 21st)

More information click here

3- April 12, 2017

Income Generation Webinar for The Options Industry Council

 

Market tone     

US stocks continued its rise records this week — including 11 record daily closing highs in a row for the Dow Jones Industrial Average. Investors appear confident that President Donald Trump will cut taxes, reduce regulation and implement a sweeping infrastructure spending program. The S&P 500 Index is up 5.3% year to date and has gained over 21% over the past 12 months. Market volatility increased slightly this week, but remains historically low. Oil prices remained relatively unchanged this week. This week’s reports and international news of importance:

  • In minutes released this week, US Federal Reserve officials signaled the potential for a rate hike at its next policy meeting in March relating to potentially increased spending and reduced taxation under the Trump administration, the minutes suggest that the Fed may act more aggressively to keep a lid on inflation
  • The central bank increased the federal funds rate to between 0.5% and 0.75% in December and indicated then the potential for three quarter-percentage-point increases this year
  • President Trump said this week that he supports a form of the proposed “border adjustment tax” (BAT), a tax on all imports. Trump suggested that such a tax would entice companies to relocate manufacturing operations to the United States, which would create more US jobs. Retail stocks have taken a huge hit in recent months over speculation that a border tax would be implemented. The retail industry imports most goods it sells in the US.
  • C. Penney announced this week that it would close more than 100 stores, and rivals Kohl’s and Macy’s announced they would lease some of their retail space to other retailers in an effort to generate more revenue from real estate assets. Under the proposal, US export income would be tax free, which could benefit some energy companies, such as crude oil exporters
  • Greece agreed to legislate pension and other structural reforms this week, generating some optimism that negotiations on its bailout terms would resume after months of gridlock. Yields on Greek government debt fell to their lowest level in a month, although serious issues still remain

THE WEEK AHEAD

MONDAY, February 27th

  • Durable goods orders Jan.  
  • Pending home sales Jan.

TUESDAY, February 28th

  • Gross domestic product Q4 
  • Case-Shiller home price index Dec. 
  • Consumer confidence index Feb.

WEDNESDAY, March 1st

  • Personal income Jan. 
  • Consumer spending Jan.
  • Core inflation Jan.
  • ISM manufacturing Feb. 
  • Beige book

THURSDAY, March 2nd

  • Weekly jobless claims 2/24

FRIDAY, March 3rd

  • ISM nonmanufacturing Feb

For the week, the S&P 500 was up by 0.69% for a year-to-date return of 5.74%. 

Summary 

IBD: Market in confirmed uptrend

GMI: 6/6- Buy signal since market close of November 10, 2016

BCI: I am currently fully invested and have an equal number of in-the-money and out-of-the-money strikes. How will nationalistic policies fare in a global economy?

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

The 6-month charts point to a slightly bullish outlook. In the past six months, the S&P 500 was up 10% while the VIX (11.47) declined by 15%.

_____________________________________________________

Wishing you the best in investing,

Alan ([email protected]) and the BCI team

 

 

 

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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.

25 Responses to “Short-Term Trades with High Returns: Evaluating a Real-Life Example”

  1. Peter February 25, 2017 8:53 am #

    Alan,

    I just wanted to ask if it would be wise generally to write puts on the strongest ETF’s over the last three months. Then, if the ETF gets put to me just write a call against? Or are there ETF’s that you just routinely use?

    Thanks so much,

    Peter

    • Alan Ellman February 25, 2017 8:59 am #

      Peter,

      Yes, this is a sound strategy approach. I refer to it as the PCP (Put-Call-Put) in my books/DVDs. I use ETFs in my mother’s portfolio and base my selections on our Premium ETF Reports. If there is one ETF I have used more than the others over the years it is QQQ which is now back on our watch list.

      Alan

  2. Jim February 25, 2017 8:55 am #

    Alan;

    I wrote a CC on HD yesterday with a $148 strike price. My net premium is $59.30.

    Yesterday the bid price on this CC was 67 cents and today it has already dropped to zero cents.

    The stock price has risen a few cents today over yesterday.

    I’ve not seen this with any of the tickers I’ve been watching.

    Any theory as to why the bid price may have dropped so suddenly?

    Thanks

    Jim

    • Alan Ellman February 25, 2017 9:00 am #

      Jim,

      Check to make sure you are comparing the same contract expiration dates. HD has both monthly and weekly expirations. Let me know…Alan

  3. Alan Ellman February 25, 2017 8:58 am #

    PREMIUM MEMBERS:

    The March edition of our Blue Chip report has been uploaded to your member site (right side) in the “resources/downloads” section.

    There are currently 8 eligible DOW 30 stocks.

    Alan

  4. Justin February 25, 2017 3:30 pm #

    Alan,

    Re your article would a Married Put be an odds on trade in such a situation? Or perhaps a long call and long put instead?

    • Alan Ellman February 25, 2017 6:51 pm #

      Justin,

      Yes, a protective put will mitigate potential losses to the downside (good point) but because the implied volatility is so high, so will be the cost of the “insurance” We must weigh the pros and cons and then decide. From my viewpoint, there are so many candidates, it makes sense to select based on our personal risk tolerance from the start rather than select one too risky and then attempt to mitigate.

      Alan

      • Justin February 26, 2017 8:46 pm #

        Thanks again Alan, yes I’m preferring the more conservative trades myself, looking for stocks with a gently rising trend as candidates usually.
        On a side note, as a dentist would you know if it’s possible to give a painless palatal injection? 🙂 (Just had implant surgery here in Australia; pain level of the injection would have been about 9.5/10).

        • Alan Ellman February 28, 2017 9:17 pm #

          Justin,

          It seems like a palatal injection in Australia is an event we want to avoid, much like an earnings report.

          Implants are a wonderful resource…it will be well worth it.

          Alan

          • Justin March 1, 2017 3:44 pm
            #

            Ha yes, though speaking of earnings reports, if a dentist gives me the most painful injection I’ve ever experienced, their future earnings won’t include any contributions from yours truly 🙂

  5. Barry B February 25, 2017 10:17 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 02/24/17.

    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

    The March edition of our Blue Chip report has been uploaded to your member site (right side) in the “resources/downloads” section. There are currently 8 eligible DOW 30 stocks.

    Best,

    Barry and The Blue Collar Investor Team

  6. Michael February 28, 2017 9:07 pm #

    Alan,

    Your elite calculator has several tabs dedicated to tax reporting. Why do I have to deal with this? Isn’t the broker in charge with providing all the necessary statements and documents for tax preparation at the end of the year?

    Thank you,
    Michael

    • Alan Ellman February 28, 2017 9:11 pm #

      Michael,

      Yes, most brokerages are getting better at record-keeping for these option-selling trades. The Schedule D of the Elite Calculator will probably be useful, but not essential, to your tax advisor. However, it also gives you final returns for each type of trade in addition to the capital gains (losses) stats.

      Alan

  7. Alan Ellman March 1, 2017 7:50 am #

    New speaking engagement just added:

    Phoenix, Arizona

    Saturday March 3, 2018 (next year)

    Details to follow

    Alan

  8. Andy March 1, 2017 12:12 pm #

    Last summer year in Virginia sponsored by AAII. One of things I thought you mentioned was if you put in a offer for options between the bid and the offer price under FINRA rules it had to be executed unless you placed special conditions on the order such as “all or none.”

    I placed an order with no special conditions on 2/27/17 to sell 10 RPM Mar 17 50 puts for .25. At the time the bid was .05 and the asked was .30. After I placed my order the bid remained .05 and the asked .30 as it did for the rest of the day. Yet my order was not executed. I inquired of Schwab why my order was not executed. This is the reply I received:
    The bid price represents the highest price a buyer is willing to pay and the ask price represents the lowest price a selling is willing to receive. When you are selling an option, the bid price must be at or above your limit price in order to be entitled to a fill. When you placed the order to sell 10 RPM 03/17/2017 50 Puts, the bid was .05 and you were asking .25. Since the bid price did not increase to .25 while your order was open, there is no entitlement. In other words, there were no buyers willing to pay .25 while your order was open.
    Did I misunderstand what you were saying. If not, is there a remedy I can pursue?

    Andy

    • Alan Ellman March 1, 2017 3:32 pm #

      Andy,

      Two comments:

      1- When leveraging the “Show or Fill Rule”, we place a limit order that slightly favors the market maker. In the case of selling into a $0.05 – $0.30 spread, I would look to set a limit order at $0.15 or $0.10.

      2- RPM may not be the best candidate for option-selling since the open interest is “0” for most strikes. Even if the trade is executed, buying back the option could be at an unfavorable price.

      It would be interesting to ask your broker “In light of the “Show or Fill Rule” why didn’t the published bid-ask spread change when the trade was not executed?” Let us know what response you receive.

      Alan

  9. Alan Ellman March 1, 2017 3:43 pm #

    NY Stock Trader’s Expo: Book signing

    Barry (left), a very happy attendee and Alan

    CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG

    Alan

  10. George March 1, 2017 3:52 pm #

    Alan,

    I had to take a break for a while due to surgery back in Dec. and now recovery time. But I’m slowly getting back into the fray.

    What would you do in this situation not withstanding commissions? I bought Charley Schwab based on the review of your Stock screener. I got in at $39 and now the stock is at $43+. That’s the good news. The not so good news is the calls I sold for .20 have now also spiked to $1.50+. Would you wait and see if the stock comes back down closer to the expiration or would you go ahead and buy it back and sell another call at a higher increment?

    Thanks,
    George

    • Roni March 2, 2017 7:56 am #

      Hi George,

      Wellcome back.
      I hope you are feeling better after your surgery.

      Your SCHW trade sounds really nice.
      If you unwind today, you will have gained $2.50+0.20 = 2.70 = aprox. 7%.
      In my opinion 7% is extremely successful. Congratukations.
      You did not inform the date and the strike, but 7% is great in any time frame.

      Have a good recovery – Roni

      • Alan Ellman March 3, 2017 8:39 am #

        SCHW has “quietly” been on our premium watch list for 11 weeks. It is popular with our members because it generates between 2-3%/month of time value initial profit for near-the-money strikes and offers a dividend (not a factor for me personally). Recently, the price has been consolidating (moving sideways) as shown in the yellow field below. This is actually healthy for a stock price in many situations. For example, the last price consolidation for SCHW is highlighted by the red arrow and that lead up to a significant price rise as shown by the blue arrow. There are no guarantees that the price rise will repeat itself but consolidation of this type is far from a negative sign especially when other technicals are healthy.

        CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG

        Alan

    • Alan Ellman March 3, 2017 12:51 pm #

      George,

      When a strike moves deep in-the-money as a result of significant share appreciation we are in the driver’s seat. We have maximized our initial trade with premium ($0.20 in this case) + share appreciation up to the strike (if you bought at $37 that’s $1.20 profit or 3.2% in a short time frame.

      When to buy back the option in this scenario:

      1- When time value approaches zero (option trading near “parity”) in the first half of a contract (mid-contract unwind exit strategy)

      2- Rolling to option as expiration approaches if the stock still meets system criteria and the time value credit meets our goals.

      Alan

  11. Jay March 2, 2017 9:31 pm #

    Alan and Barry,

    I am glad you guys cover ETF’s, Blue Chips and Growth Stocks. Surely everyone can find their oyster in there somewhere :)?

    It has been a frustrating few months for me as most other investors do the Happy Dance over the Trump rally!

    I was one of those doubting Thomas’s who stayed too much on the sidelines. I did not lose anything except opportunity because I never shorted. But there is still a restless agitation when you get the market completely wrong or suffer timidity in good times.

    It is an astounding market. We are already at the YE targets a few big houses put out there. It has been almost a hundred trading days since the S&P went down more than 1% in a day. Bullish sentiment readings are getting stratospheric. The VIX actually went down today as the S&P declined!

    Maybe Janet will rain on the parade with a rate hike this month. But it seems equally likely that, as at Woodstock, the festival goers will party on in the rain if she does :). – Jay

    • Roni March 3, 2017 4:31 pm #

      Hello Jay,

      Don’t be sad, “better restless than broke”.

      They call it the Trump rally, and it is probably true, as most investors like his program, even if they do not like the man.

      I believe that this is actually a post elections rally. No more uncertainty, and no major events up ahead.

      So, with no alternatives, people turn to stocks for yield, and as the market rises, more and more people want to participate. (until the money on the sidelines is exausted, and everybody rushes for the exit)

      The only wild card is Trump himself. Hee, hee, hee……
      But I believe the American system will prevent him from doing major damadge.

      Roni

      Trump is the wild card

      • Jay March 3, 2017 6:27 pm #

        Hi Roni,

        Thanks for the encouragement! I hope you catch this reply as we are about to change threads in the morning.

        People forget cash is an asset class like stocks, bonds and gold. You always need to have some around. My mistake in hind sight since the election is I kept too much of it. Now I am reluctant to chase stocks or the market at these levels.

        Many pundits say Trump grew into the job with his speech this week. He still says far too many things that alienate me to ever support him. But to fight the market tape against him would be as dumb as fighting the Fed :)! – Jay

        • Roni March 4, 2017 3:09 pm #

          Got it Jay.

          See ya.

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