Many consider covered call writing and selling cash-secured puts the same strategy with the same risk-reward profiles. To me, they are similar with slight differences that must be understood to make a decision as to which strategy to favor. In the end, it will be like selecting between an ice cream sunday topped with whipped cream and one with hot fudge…both great and a simply matter of preference. That said, there are both similarities and differences and for those of you have my book, Alan Ellman’s Selling Cash-Secured Puts, I invite you to view the comparison chart on page 214. In this article, we will highlight two of the more common reasons given for favoring put-selling over covered call writing. Counter arguments will then be presented.
Lower commission fees for put-selling
Pro put-selling
When we sell a cash-secured put, there is one initial commission of a base price plus an additional fee per contract. As an example, the commission for 5 contracts may be $8.75 + 5 x $0.75 = $12.50.
When we write a covered call on a stock not yet owned, we have a commission to buy the 500 shares at a fee of $8.75 plus the $12.50 for the short call leg.
Counter arguments
When we enter a covered call position, we have an opportunity for two income streams when we sell an out-of-the-money call, one from option premium and one from share appreciation up to the strike. Let’s say XYZ is trading at $47.50 and the $50.00 out-of-the-money call and the $45.00 out-of-the-money put both generate $1.00. The initial returns are similar with the put-sale generating a slightly higher initial return (since the put premium is deducted from the required cash to secure the put obligation). Our maximum profit from the put sale is locked in at 2.2% whereas the covered call has $2.50 of potential additional profit if share price moves to the $50.00 strike. If that occurs our new covered call profit would be $3.50/$47.50 = 7.4%, well above the 2.2% put profit. That additional $8.75 covered call commission now looks like money well spent when comparing it to the $250.00 per contract earned if share price moves to the strike.
Let’s play devil’s advocate a second time on this one. A proponent of put-selling may say that we counter the share appreciation potential from covered call writing by selling an in-the-money put and generate a higher premium and therefore a higher return. This is true and may work out but the basis of favoring put-selling with this argument is that the investor does not want to purchase the shares and by selling an in-the-money strike, there is a greater chance of those shares being “put” to us. Now we can avoid this by buying back the put but that would cost us an additional $12.50 in commissions using the hypothetical fees above. There is a possibility that in this scenario we are actually paying higher commissions for a put sale.
If a trader is favoring in-the-money puts, it would be best utilized in a bull market environment where there is an increased chance that share price will move above the put strike thereby eliminating inevitable exercise. However, in a bull market why not go with an out-of-the-money call and generate both income streams?
Cheaper to close for a partial profit when share price rises when selling puts
Pro put-selling
When share price rises, put strikes move deeper out-of-the-money while call strikes move deeper in-the-money. The argument suggests that the put bid-ask spreads will be tighter (closer) than those of call options. This is absolutely true but you know there are counter-arguments coming.
Counter arguments
The two questions that come to mind are:
- How significant is the spread difference?
- What about the cost-to-close if share price declines (uh oh)
Let’s view a real-life 1-month options chain for Facebook, trading at $119.00:
Facebook Options Chain
If share price moves up, the $110.00 strike would be $9.00 in-the-money on the call side and $9.00 out-of-the-money on the put side. The spread is $0.15 for calls and $0.05 for puts. Let’s give put-selling a $10.00 per-contract advantage in this regard. Now remember the $250.00 potential profit from share appreciation covered call writing offers when selling out-of-the-money strikes when factoring in spreads and determining the best strategy to utilize.
Furthermore, share value can also go down (has that ever happened to any of you?…me too). As an example, we look at the $130.00 strike which is $11.00 out-of-the-money for calls and $11.00 in-the-money for puts. Here we see a spread of $0.04 for calls and $0.15 for puts, similar to the above scenario when shares price rises. Even more egregious is the much higher cost to close the short puts ($11.55 versus $0.59) resulting from put value increasing when share price declines.
Discussion
While it is true that put-selling may involve lower commissions than covered call writing and tighter spreads when share price rises, we must look at other pros and cons of these strategies and all circumstances in order to make an informed decision. I have made it clear over the years that I favor covered call writing but selling cash-secured puts (I generally do not favor margin accounts for most retail investors) is a wonderful strategy that can make us a lot of money when mastered. In bear markets, I use put-selling to enter a covered call trade (PCP strategy in my books and DVDs). It ultimately boils down to whether you like whipped cream or hot fudge.
Next live event
Long Island Stock Trader’s Meetup
Tuesday May 9th, 2017
7 PM – 9:30 PM
“Using Stock Options to Buy Stocks at a Discount and to Bring Portfolio Returns to Higher Levels”
Admission is FREE
Market tone
Global stocks rose this week because of improved economic growth, especially in Europe. Slumping oil prices is a concern with the price of West Texas Intermediate crude falling to nearly a six-month low, ending the week near $45.50, down from $49.00 last Friday. Volatility, as measured by the Chicago Board Options Exchange Volatility Index (VIX), held steady at 10.57. This week’s reports and international news of importance:
- Friday’s US employment report was positive, with 211,000 added to payrolls in April versus a downwardly revised 79,000 in March
- The unemployment rate fell to a 4.4%, a 10-year low
- Average hourly earnings increased a less-than-expected 2.5%. The report paves the way for likely rate hikes from the US Federal Reserve at its June meeting
- Emmanuel Macron, seeking elective office for the first time, looks poised to win the French presidency on Sunday. He leads right-wing populist Marine Le Pen by an average of 20 points in opinion polls
- Economic growth in the eurozone grew at an annualized pace of 1.8% in the first quarter of 2017, outpacing US growth, which was an anemic 0.7% annualized rate over the same period
- After months of Republican infighting, a bill to repeal and replace Obamacare emerged from the US House of Representatives this week. The bill will likely face a stiff challenge in the Senate. A Senate vote on the measure is expected to be some months away.
- Puerto Rico filed for a form of bankruptcy this week. The territory is weighed down by approximately $75 billion in debt, making the filing the largest in US history
- As of May 3rd, 357 of the 500 constituents of the S&P 500 Index have reported earnings for the first quarter. Earnings are expected to increase 14.2% from a year ago. Stripping out energy, earnings growth is 10%
- Revenues for the quarter are expected to increase 7.2%. Ex energy, they are expected up 5.3%. The next-twelve-months earnings estimate for the S&P 500 is 17.7x
THE WEEK AHEAD
MONDAY, May 8th
· None scheduled
TUESDAY, MAY 9th
· NFIB small-business index April
· Job openings March
· Wholesale inventories March
WEDNESDAY, MAY 10th
· Import price index April
· Federal budget April
THURSDAY, MAY 11th
· Weekly jobless claims 5/6
FRIDAY, MAY 12th
· Consumer price index April
· Core CPI April
· Retail sales April
· Retail sales ex-autos April
· Consumer sentiment May
· Business inventories March
For the week, the S&P 500 moved up by 0.63% for a year-to-date return of 7.17%.
Summary
IBD: Market in confirmed uptrend
GMI: 6/6- Buy signal since market close of April 21, 2017
BCI: With a solid earnings season and a positive employment report, I am moving to a slightly bullish portfolio tone favoring out-of-the-money strikes 3-to-2.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
The 6-month charts point to a moderately bullish outlook. In the past six months, the S&P 500 was up 12.5% while the VIX (10.82) declined by 43%.
_____________________________________________________
Wishing you the best in investing,
Alan ([email protected]) and the BCI team
Justin,
here is a screen shot from one of my watch lists from Yahoo Finance.
Roni,
Yes I’ve been creating a large list on Yahoo myself – not for viewing option chains since Nasdaq.com is much faster for that, but for the fact that I can copy and paste data from a large list into Excel and extract the latest stock price in an automated process I’m working on. Do you know by how much the Yahoo data is delayed?
Justin
Justin,
The data I use on this summary page (price, change, %change, volume) is real time, and is updated every few seconds.
I also use the detailed page for each individual ticker, where I look at the chart (1day, 5days, 1month, 6months, and 1year), which is also real time, and shows market cap, PE, earnings date, dividend yield, and recent news.
From there, I go to options page for an overview. It is also real time, but I always choose strikes from my Schwab trading page, which is more accurate and dependable.
Roni
Hey Roni,
I look forward to Justin’s thoughts but that looks like a good little group of health care/pharma related stocks.
I did not chart them all but when I placed BSX, ILMN and WBA on a chart with SPY and XLV I saw about what I expected. Greater swings but higher performance in BSX and ILMN, WBA tracking XLV which is off a bit compared to SPY since health care and drug costs became a political football at least in the US.
I am not as focused on the sector as I was a few years ago because of news risk but it is clear strong stocks will do well. Demographics are on their side if a little volatility does not bother you! – Jay
Hello Jay,
This screen shot shows only 6 tickers, but the full page has 23.
I do have about 30 different pages in my Yahoo portfolio, each with tickers from different industries. Some have only a few tickers, but most have more than 10. (compiled in the last 6 years).
I look at some each day, and include/exclude tickers as I go.
Also I check all of them on weekends, specially on options expiration weekends.
My yahoo portfolio has one page called “my Trades” which contains the 8 or 10 tickers I’m currently invested in, which I keep updated constantly.
I also have one called “5 Stars” whith my prefered stocks, chosen for their strong, healthy, and BCI compatible monthly options conditions.
Keeps me busy.
Roni
Alan,
Thanks for another great blog. I look forward to reading any follow up discussion this week.
I suspect you posed the question “should we favor…?” for learning and sharing. My opinion is the two compliment very well. It is a rare month when I do not sell both covered calls and cash secured puts.
Most often the calls are on things I own and the puts are on things I would like to own at a lower price.
Lot’s of great uses for both approaches in any market! – Jay
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 05/05/17.
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
Since we are in Earnings Season, be sure to read Alan’s article, “Constructing Your Covered Call Portfolio During Earnings Season”. You can access it at:
https://www.thebluecollarinvestor.com/constructing-your-covered-call-portfolio-during-earnings-season/
Best,
Barry and The BCI Team
interesting article as always. I never hear much mention of doing a covered call and selling a put all at same time on favored stock to really enhance the return, with the possibility of accumulating more shares at a greater discount. Any one making that kind of trade?
Hey Dennis,
I do something similar, just not all at the same time because I like selling calls on up days and puts on down days.
If I am long a stock/ETF and have it covered but I also have my eye on adding shares I will sell cash secured OTM puts – maybe out a bit further in time – on a down day when put values are higher and I can get more downside room selling the put further under what (I hope) is just an ordinary dip down day on a stock/ETF I am bullish on. – Jay
Dennis,
I often sell “covered strangles” on stocks that I would not mind owning more of.
Jack,
Please let me make sure I have it right. And since you use the “covered strangle” often I would love to know how you structure them, i.e, balanced or lopsided wings by market view? Any recent example would be great.
I have always layered in on different days but can see why you like this tactic. I priced one hypothetically this afternoon knowing the market will likely be different in the morning.
I used one QQQ contract assuming I own 100 shares, would like to cover them and buy 100 more during June expiry. So I picked two strikes of similar delta OTM high and low to sell for June.
QQQ closed at $137.54 Friday. I priced the 140/134 covered strangle selling the 140 covered call and the 134 cash secured put for $1.87 Just the call would get .90 cents and just the put would get .97 cents.
The market can not be two places at one time. Assuming no exit strategies (I know, terrible assumption but I am trying to understand the concept first!) I will either keep my shares and my $1.87 if it stays within my strikes, get called at the equivalent of a $141.87 sale if QQQ goes up or add my new shares at a $132.13 basis if QQQ drops.
That’s over 3% leeway from current market in each direction in one month on an ETF I own anyway and would not mind buying more of. Not bad!
Am I missing anything? Do you do it differently? I can see weighting one wing or the other heavier for market bias which I suppose I do when I leg in on different days. But your strangle maximizes theta decay on both sides if using the same expiry. Thanks for the idea, -Jay
Alan,
I do favor covered calls because I trade exclusively in monthly options, and almost never hold a stock for more than 1 or 2 months.
Also, my trades are buy/writes, to avoid sudden drops in the calculated ROO, and save on the extra commission.
Beat by BEAT
This month I made 2 big mistakes, and lost $2,500.00. Ouch! 🙁
Mistake#1
BEAT was supposed to report earnings on 04/25, and I entered a trade on 04/26, failing to see that they delayed it to 05/03.
Mistake#2
When I finnaly noticed it a few days ago, BEAT was doing well, and I decided to take it through earnings.
But despite the favorable report, BEAT dropped 18% early the next day, and I bought back my calls for a few cents.
By the end of that day, BEAT was down 15%, and I sold all of my shares, and entered a new trade on a better soldier.
The BCI golden rule proves to be very, very important.
Roni
Roni,
Thanks for the reply above detailing your watch lists and how you follow them both through Yahoo and Schwab – very helpful and impressive – and you still run your other business at the same time :)?
As for BEAT you are just being your humble self: you did not make any mistakes. You entered the trade with the best info you had, earnings reports frustrate us all when they move on no notice and you made a reasonable decision to hold the stock once you saw the amended date vs. current price action.
You certainly did better than BEAT investors who had no covered call. You then made the decision to stop your loss and move on.
Knowing you I bet you did not have much of your portfolio in BEAT to begin with. It was just another stock.
The key thing is you did move on. Often times people new to these excellent strategies – and I know you are far from that – will have a bad experience with one stock and give up mistakenly thinking the option strategy was the problem when it was just bum luck with one stock. – Jay
Jay,
BEST was a troublesome ER issue. I issued a report update and even placed two calls to the BEAT CFO to try get an accurate ER date for our subscribers never got a call back. The ER date was eventually disclosed in a press release.
ER dates give me the more problems than anything else…even though I use multiple sources for the data. The sources include:
– Earnings Whispers
– CBOE
– Schwab
– IBD
– Yahoo
– Finviz
– In some cases, the company website
With all of these sources, many times I still get conflicting data. So, if you are not sure, fecundity the company website.
The good news is that the vast majority of our ER data is accurate..
Best,
Barry
P’S.: Sorry for any typos…in the car with my wife driving.
Barry,
It was my fault.
On 04/26 before I entered the trade, I saw the title of the news :
“BioTelemetry, Inc. to Release First Quarter 2017 Earnings Results on May 3, 2017”.
But somehow I misunderstood it and assumed it meant that BEAT had reported the previous day, and did not counter check with EW.
Will be more careful in the future.
Roni
Jay,
Thanks for your kind words.
My other business does take up a large part of my time. And that is why I trade exclusively in monthly covered calls, in order to simplify.
My call premium on BEAT was 1.55 per contract, and I bought them back for 0.10, mitigating my loss considerably, but still…..
Roni
Definitely a good article. I have read and do own the “Selling Cash Secured Puts” book. While the market was getting a bit choppy in consolidation and putting me “on notice” I was selling ITM covered calls. I finally decided that selling ITM covered calls is essentially equivalent to selling OTM cash-secured puts with less commission. So, I’ve done some more put selling on some good stocks or well-performing ETFs. My market metrics have turned up a bit and are in the bullish category (+2 on a scale of -3 to 0 to +3 which improved from being negative for a bit this year) so I may scale that back and be focusing on long stock and short calls again.
In any case, I am continuing to work within the system and tweak things as I hone my skill set. I also “spread-off” one short put on entry creating a bull put spread (at entry, I’m not a fan of making such adjustments mid-trade. By then I think it’s too late and too costly). I was comfortable with the net credit and it reduced my value-at-risk quite substantially. This was a calculated trade-off between selling an OTM put or an ATM put. It paid me better to be a bit aggressive on the short strike and sell ATM and cover myself on the long strike with a long OTM put than play it a bit less aggressively.
Sports analogies might be something like a 5-foot putt on the green or a 10-foot chip from the fringe. They’re both reasonably high percentage plays but one may be more comfortable depending on conditions. With my metrics going more positive, I stepped up a bit more aggressively (in a chicken way because my emotions don’t love it). I’m starting to get a bit more confident in the market with so many great looking technical indicators as well as price action confirming bullish.
Alan,
I know you advocate buying the shares first and then selling the option, but has there ever been a case where you’ve put in a cheeky sell order (before buying the shares) for a DITM option in the middle of a large spread, where if you get filled you’ll get a large amount of downside protection? One example I can see after running a scan is the TREX May 60 strike with a share price of 68.12 and a spread of $7.50 – $11. A sell bid at 9.25 if filled would get a ROO of 1.9% and downside protection of about 12%. (The ER was last week.)
Justin
Justin,
There are several areas of concern I have that need to be explored before entering a trade like this:
1. TREX has an average trading volume < 200,00 shares/day, not meeting our threshold of > 250,000
2. The open interest liquidity of 80 falls a bit short of our criteria of > 100 contracts of OI
3. Any option that generates nearly 2% of time value with 12% of intrinsic value, by definition, is a volatile underlying security…not for everybody
4. Most retail investors will have difficulty getting approval to trade naked options
That said, this proposed trade may be appropriate for those who have a much higher risk tolerance than I have. For most retail investors, in my humble opinion, naked options should be avoided or used with extreme caution.
Alan
I agree with Alan, wholeheartedly. I think you may find that you won’t get filled at mid-price, either. With a b/a that wide, the MM will probably just post the ask that you throw in and will be more than happy to have you improve the spread for it. With a DITM option, you’re probably going to be very close to intrinsic value plus a small time premium and after commissions, you’re probably looking at a zero-gain to a small loss.
What you see a wide bid/ask, you’re looking at an “inefficient market” and as a market taker rather than a market maker, you’ll probably find not only is there no free lunch but whatever free lunch might occur is on you.
Thanks Alan and Geoff,
Sorry if I didn’t make myself clear – I don’t like naked options either, the plan, such as it is, would be to immediately buy the shares if I managed to sell the options. Geoff – since I hadn’t yet bought any shares it wouldn’t matter if the MM adjusted the spread since I could just cancel the offer. Re commissions IB charges less than $1 for option trades. It’s all academic anyway – I checked with IB and sadly (or not) my cash account isn’t allowed to write naked calls, though apparently margin accounts based in the USA can (I’m in Australia.)
Justin
Justin,
it seems to me that what you want is buy/write.
Does’t your broker have this alternative ?
Roni,
Haven’t looked into that – would that allow you to say buy the shares but only if the call option was sold first?
Justin
Yes Justin,
buy/write is a simultaneous trade, you fill both legs of the operation in the same screen, and you can choose “market”, or “limit debit”, and if you get a fill, you will be charged only 1 comission.
Roni and Justin,
Great discussion. Roni, I know you do new monthly buy/writes on the same ticket and I think Alan does too. I suspect, Justin, your broker in Australia will allow you to do the same thing.
There are many advantages including maximizing theta decay, instant down side protection, saving time and maybe commissions.
On the flip side here is why I never do it: when I buy something I have a bullish outlook understanding I could be wrong. The market is not linear so I buy on down days and sell calls on up days. I only use ETF’s/Large Caps that have weeklies so I can create “months” of my own choosing. I want new holdings to run before covering them. Even if I have to wait them out.
This is, of course, only my opinion and how I do it. I hold things longer than many covered call writers do. Expectations about portfolio holding period will impact how you play this game dramatically.
As always, there are many ways to apply options selling strategies! – Jay
Hi Jay,
your method is very good, and gives you the opportunity to enhace your gains considerably, at a slight additional risk.
I will start doing the same in the next options cycle.
I prefer the monthlies becaus most of the time OI is very low on weeklies, and the bid/ask spread is above the $0.30 level indicated by Alan.
Also, it seems easier to manage my portfolio when all the calls expire on the same date. 🙂
Roni
Hey Roni,
You have an established process and discipline that works for you consistent with traditional covered call writing. I would not change your approach based on a post from me :)!.
Maybe pick one or two stocks off the Blue Chip list and do as I outlined while you keep doing what you normally do with the rest of your portfolio. That way you see which you prefer from a results, time commitment and personal preference perspective. You might find a blend of both approaches works going forward? – Jay
Planning to do as you say Jay. Thanks.
Roni, best of luck with both “buy/write” and “buy/wait” as I call my approach :). – Jay
Jay,
yesterday my ATVI and AVGO 05/19 trades maxed out, and I exited both trades.
This morning, (down day) I used part of the resulting cash to buy/wait WDC at 88.88.
A few moments ago I sold the 05/19 90.00 calls for 1.25.
Now I’m looking at a very nice 1.4% ROO, plus potential 2.7% total if exercised next week.
Biginner’s luck of course, but good omen.
Roni 🙂
Roni,
Well done.
Buy/write works best on stocks about to go down. Buy/wait works best on stocks about to go up.
So balance must be struck. Maybe a little bit of both. -Jay
Will do, thanks. – Roni
Alan,
Few months back, I purchased your books and spent many hours studying them and reading the books 2-3 times. I must say the books are very well written and I really enjoyed the learning process. I am now practicing and testing my knowledge with paper trading.
When thinking about why the holder of a call option contract would eventually exercise the option before expiration Friday, there is something I do not fully catch: If the price of the stock is above the strike price prior to expiration friday, and being the time value zero or very close to, why the option contract holder is not selling the call option instead of allowing the exercise of the same (buy shares at the strike price and then sell them to the market at a higher price). Prior to expiration friday, the time value of the call option is almost 0 so all its value is basically is intrinsic. Wouldn’t he/she be in a similar situation by selling his/her contract (sell-to-close) and at the same time save some buy/sell commission fees?
With Kind Regards,
Marcos
Marcos,
Very rarely will an option holder exercise right before expiration and then immediately sell the shares to capture intrinsic value. Most option contracts are closed prior to expiration with a very low percentage (10 -15%) actually exercised.
As you said, one less commission + capture of perhaps a small amount of time value. Exercise will occur if the holder actually wants own the shares (in which case the shares will not be sold) or when there is an ex-dividend date prior to contract expiration.
Bottom line: your intuition is absolutely correct.
Alan
Thanks to all attendees for making last night’s seminar a successful learning experience for us all. Great questions and dialogue.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG
I came across an interesting article on options strategy from Goldman Sachs that I am sharing for comments.
“A Time-Tested Options Strategy that Doubles the Market”
by Grant Wasylik, Editor, Disruptors & Dominators
How do stocks respond to earnings?
Obviously, some rise and some fall. It depends on their numbers and their guidance.
But history shows there are more “beats” than “meets” and “misses.”
The last couple years, part of the high probability of beats is attributable to what legendary hedge fund manager David Einhorn calls the game of “beat and lower.” (It used to be “beat and raise.”) Meaning, companies lower the bar, to beat the bar.
Whether it’s “beat and lower” or “beat and raise,” companies have been consistently topping earnings estimates for some time. Quarterly earnings beats haven’t dipped below 50% dating all the way back to 1999. And beats have averaged close to 63% over the full range in the chart above.
It shouldn’t be shocking that global investing powerhouse Goldman Sachs (GS) has already studied this phenomenon. The firm concluded, after two decades’ worth of research on long-term earnings effects, that stocks increase an average of +0.7% following earnings.
I know … an average gain of less than +1% doesn’t sound like much to sink your teeth into. But, with gobs of companies reporting earnings, those small gains can add up quickly.
Naturally, Goldman Sachs, who was long $54 billion — and short another $47 billion — of derivatives at the end of last year has a more-effective tool to capitalize on this approach:
Add an options component to the mix.
If the average stock rises in price based on earnings, the related calls move higher in tandem.
The results of their study, conducted from 12/31/1996 to 12/31/2015, is why the company has long recommended buying call options on stocks before their companies report earnings.
Goldman’s options research group reports the strategy of buying at-the-money, one-month-out calls across the board has produced an average gain of +14% (excluding transaction costs) over the 19 years studied. (It was profitable every year, too.)
In contrast, the S&P 500 achieved a +7.4% annualized return over the same period (with four down years along the way: -9.1% (2000), -11.9% (2001), -22.1% (2002) and -37% (2008).
Can options trading really be this simple?
The data dictates that it can be.
Last week was busy with about 20% of the market reporting …
I read an academic article recently and it showed that 70% of “catastrophic” stock collapses happen as a result of earnings. Maybe you want to start doing call ratio back spreads and such? For me, I think Alan really has designed a good system for a lot of reasons. I’m staying with the program and keep making my returns.
I’ve added some bull put spreads on ETFs, though. So, a minor adjustment here or there.