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When selling covered calls or cash-secured puts, using contract expirations several months out (or longer) have the appeal of large option premiums. However, when we annualize these returns, they pale in comparison to the returns generated by shorter-dated expirations. Another concern related to longer-dated expirations is the potential exposure to risky earnings report events.

What is the Square Root Rule?

This rule applies to at-the-money (ATM) strikes. Simply stated, it takes approximately 4 x the time to double an option price when using longer-dated ATM options. If a 1-month option return is $1.00 per share, to double that to $2.00, we would have to go out 4 months. The square root of 4 = 2. Let’s add more color with a real-life example using Apple Inc. (Nasdaq: AAPL).

AAPL 8/16/2024 expiration option-chain on 7/15/2024

With AAPL trading at $230.43 on 7/15/2024, the $230.00 ATM strike shows a bid price of $7.80. Now, if we go 4 months out, will we receive 4 times that amount, $31.20? The square root rule states that we will receive only double that amount, the square root of 4 = 2. Let’s see.

AAPL 11/15/2024 expiration option-chain on 7/15/2024

With AAPL trading at $230.43 on 7/15/2024, the $230.00 ATM strike shows a bid price of $15.20. This is approximately double the 1-month $7.80 return, not even close to quadrupling that initial return.

Discussion

Using shorter-dated options will result is greater annualized returns. It will also assist in avoiding earnings report events and, in some cases, ex-dividend dates. Let’s not be enticed by large initial premiums until we put those cash returns into proper perspective and evaluate the pros & cons of using these options.


Stock Repair Calculator


What is the stock repair strategy?
  • Own shares at a price higher than current market value (unrealized loss)
  • Willing to forego potential profit in exchange for lowering the breakeven price point
  • Not willing to add additional funds to the current losing position
  • Instead of buying shares at the lower price to “average down”, an at-the-money (near-the-money) call option is purchased and funded by selling 2 out-of-the-money call options
  • 2 long positions (stock and ATM or NTM call)
  • 2 short positions (OTM calls, covered by long positions)
  • This action will lower the breakeven price point
  • The strategy does not protect against additional downside loss
  • The strategy does cap the upside

Click here to learn more.


Your generous testimonials

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 publish several of these testimonials in our blog articles. We will never use a last name unless given permission:

Hi Alan,
 
Another great workshop. We pick up something new every time.
 
Thank you,
John
 
 

Upcoming events

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1/16/2025

8 PM ET – 9:30 PM ET

The Collar Strategy: Covered Call Writing with Protective Puts

Protecting covered call trades from catastrophic share loss 

This is the strategy Bernie Madoff pretended to use. He called it the split strike conversion strategy, but it was simply a collar. The covered call sets a ceiling on the trade and the protective put guarantees a floor on the trade.

Topics discussed

  • What is the collar strategy?
  • Uses for the collar
  • Entering a collar trade
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February 13, 2025

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Covered Call Writing Dividend Stocks

 

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  1. Ultra Low-Risk Approaches to Covered Call Writing and Selling Cash-Secured Puts
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Cash-Secured Puts: 2 Outcomes

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Thursday May 15, 2025

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Alan speaking at The All Stars of Options event in Las Vegas