Stock selection is the first of 3-required skills essential to become an elite option-seller. Option selection and position management are the other two. On 3/31/2019, Sunny wrote to me inquiring about 2 stocks, Edwards Lifesciences Corp. (NASDAQ: EW) and Regeneron Pharmaceuticals (NASDAQ: REGN). He was deciding between these 2 securities in the “medical industry” and noticed that EW had been on our premium stock report eligible list for 9 weeks while REGN was a new entry that week. He wanted to know how much weight to give this secondary parameter. Since both securities are listed in the “white (eligible) cells” of our premium stock report, we know that they are both elite-performers from fundamental, technical and common-sense perspectives. Let’s have a look at that report when Sunny sent this email.
Premium Stock report created after market close 3/29/2019:
A closer look
Similarities (red arrows left to right)
- Both have industry ranks of “A”
- Both have similar mean analyst ratings (2.30 and 2.50)
- They have similar beta stats (1.34 and 1.21)
Differences (blue arrows left to right)
- EW is priced less than half of that of REGN ($191.33 compared to $410.62): advantage EW
- On balance volume is steady for EW but declining for REGN: advantage EW
- EW has been eligible on our premium stock reports for 9 weeks while REGN is on for the first time: advantage EW
Both securities are outstanding candidates for option-selling. When viewing the secondary parameters, we give a slight edge to EW.
Sunny’s inquiry was primarily focused on the number of weeks on the premium stock list. There is no one parameter that will include or eliminate an eligible stock from consideration. Rather we use a mosaic of all the report information to make our final decisions.
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 share some of these testimonials in our blog articles. We will never use a last name unless given permission:
I would like to thank you for all your free content on the web and YouTube… the best out there in my opinion.
In most cases this free content is just an enticement for buying into one’s “system”. You seem to be different and often give alternatives to your pay site and we applaud you for that.
John and Dawn
September 26 – 27, 2019: Philadelphia Money Show
Thursday September 26th: All Stars of Options
Friday September 27th at 1:30 PM: “How to Select the Best Options in Bull and Bear Markets”
***I will be doing a book-signing event in the exhibit hall after my Friday presentation at 2:30 PM.
Market tone data is now located on page 1 of our premium member stock reports.
I have a question regarding PMCC and rolling-up.
In August and September this year I made a series of PMCC trades on TLT. My initial plan was to sell weeklies, but TLT appreciated in value too fast and my calls went ITM. TLT pays dividend once a month, so to avoid being assigned I rolled to the further dates trying to capture more time value to avoid the assignment. I closed the entire position this Friday and now have trouble understanding if this was a winning or a losing trade.
I bougth 10 Jan 21 $120 Call contracts for $16.60 and I sold them for $19.20 making $2600 total. By selling and buying the options back I lost -$3.32 or -$3320. And I rolled-up twice (from $136 to $137 and from $137 to $138) adding $2000 cash to my positions.
What is the final outcome for this trade?
P.S. And thanks for mentioning me in this week’s article again 🙂 Ironically I just initiated covered call trade on EW yesterday as this stock still appears on BCI reports.
If I interpreted your stats correctly, you have a net credit on the long call side of $2600.00 and a net debit of the short call side of $1320 leaving a net position credit of $1280.00. This represents a 7.7% return.
Your experience with this trade demonstrates the critical significance of initial trades structuring when using the PMCC strategy. It must be set up such that, if we are forced to close due to a significant price acceleration, we must close with a profit. Here is that formula:
Difference between the strikes + initial short call premium > cost of LEAPS option.
See Chapter 16 in our book, “Covered Call Writing Alternative Strategies” for more information on initial trade structuring. The first tab in our PMCC Calculator will do all that math for us.
Congrats on a successful trade!
I always enjoy your contributions to our group. I’ll be interested to read how the calculations on your trades work out but I suspect you will be fine.
I think it is a must to have at least some TLT and GLD in any long term portfolio, They have been on a roll this year, that won’t always be the case and they have been tough to chase with covered calls.
Heck, if someone asked my two cents on how to manage a million dollar IRA account in retirement I would tell them put 50% in SPY, 20% in QQQ and 15% each in TLT and GLD. Over write half of it at 1% OTM every month and let the rest run free. You spin off $5,000 cash flow per month and if you can’t live on that you shouldn’t have retired )! But just my opinion which also illustrates the power of these strategies. – Jay
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 09/13/19.
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:
Barry and The Blue Collar Investor Team
In all of your material, you don’t mention the probability of ITM or OTM success in an options trade as being a criteria of entering or not entering. Why is this a non-factor for Blue Collar Investors? I’m assuming it’s because the focus is more on your team’s screening of the selected list of stocks, your suggested ratio of ITM vs. OTM strike positions every week, and the 2% – 4% premium you seek in each trade………..and then of course how you manage your position between entering and end of expiration. Is that correct, or is there another reason you don’t advise factoring in probability?
It is my hope and mission that the rules and guidelines inherent in the BCI methodology focuses like a laser on the probability of success of our trades.
When most investors speak of probability of success, they are referencing “Delta” or the probability of the strike expiring in-the-money. ***There is no one Delta that is correct for all our covered call trades…period***
However, when we sell an option, that option will, of course, have a Delta. So how do we get to that Delta for that specific trade?
1. Decide on the “moneyness” of the option based on overall market assessment, chart technicals and personal risk-tolerance.
2. Decide on an initial time-value return goal range (2% – 4% in my case).
3. Go to an option-chain that meets these criteria and the Delta for that strike is the correct one for that trade at that time.
Your assessment as to why we don’t name a specific probability (Delta) is spot on.
Excellent, I understand. Thank you very much, Alan.
Thank you for sharing your wisdom on covered calls. I am a premium member and I just have a couple of questions:
1. Which of these two would be better for covered calls (assuming similar technicals, current market conditions, and similar annualized returns):
A.) an ATM or OTM option with a stock that has low volatility
B.) a deep ITM option with high downside protection but the underlying has high volatility (i.e., GDXJ, OLED, TWTR)
2. I recently bought GDXJ and CDW, both of which are in the Weekly Screening List, and sold ITM options. The technical looked good when I bought them, but for some reason, they still went down a few days after. I bought back the options once they hit 20% of the original premium, but I haven’t sold the stock. I have two questions on this matter:
– I am hoping to hit a double on these stocks. But assuming current market conditions, how long do you usually wait before you decide to roll down or sell the stock, if the price does not bounce back?
– For options that started deep ITM then went down, the 20/10% guidelines are computed against the original premium, correct? (Even if the intrinsic value dropped or disappeared)?
1. If we are bullish, we favor out-of-the-money strikes. If bearish, in-the-money strikes., The implied volatility is “baked” into the time-value of the premium. Once we set up an initial time-value return goal range, staying within that framework will work whether the underlying has a high or low implied volatility.
2. Favor “hitting a double” in the first 2 weeks of a 4-weeek contract and in the first 3 weeks of a 5-week contract. Favor rolling-down in week 3 of a 4-week contract and in week 4 of a 5-week contract. Consider selling the stock at any time if it is significantly under-performing the S&P 500. THESE ARE GUIDELINES.
3. Yes, the 20%/10% guidelines apply to the full original premium of ITM strikes.
First I’d like to thank you for making the writing beginners course comprehensible. Many people start off saying its simple but by half way through they are no longer talking about covered calls.
I have been able to follow you quite easily so far. Next question, havn’t seen anyone address this and I’m wondering what am I missing. Selling a covered call deep in the money. Purchase stock for 21.50, strike price of 14.00 w a 11.40 premium. Downside deeply protected, premium outstanding, and I don’t care if it gets called. Obviously best scenario is too expire, but is this too good to be true? No one ever talks about the extremes or hidden traps. What say you?
Well, Walter, you sure have my interest and if this is a real trade I would love to know the ticker and expiry so I can follow it :)!
Even if you are un Uber- Bear on whatever security this it would be fun to use here for learning purposes !
You bought for 21.50 and sold ITM at 14.00. So that’s 7.50 down off the bat. But you got 11.40 which you keep forever. I can see this working! I just would not have used such extreme strikes :)! – Jay
One of the basic principles of investing with stocks and stock options is that there is no free lunch. We must keep this in mind no matter what promises we hear on TV or other venues.
Like Jay, I’m curious if this is a real-life example or a hypothetical and the time-frame or contract expiration. Either way, let’s breakdown the math using the multiple tab of the Ellman Calculator (see screenshot below):
In this example, we receive an initial time-value profit of 27.9% with 34.9% downside protection of that profit. The breakeven is all the way down to $10.10.
On initial glance, this does seem too good to be true. Then we must ask ourselves why an investor or market-maker would take the other side of this trade. The answer is simple… the implied volatility of this stock is through the roof. Deep in the money strikes typically do not offer this type of return unless the stock is extremely volatile meaning we are incurring significant risk to the downside despite the protection inherent on the premium.
The call buyer’s breakeven is $25.40 ($14.00 + $11.40), a rise of 18% from current market value and that’s just to breakeven so the anticipation is much higher.
Most covered call writers (and put-sellers) are conservative investors with capital preservation in mind and that’s why these strategies were selected. To avoid risky positions, we must set an initial time-value return goal range that will keep us away from these type of trades. I favor 2% – 4% in my accounts and 1% – 2% in my mother’s. Setting up a similar range based on our personal risk-tolerance and investment goals will keep us out of trouble.
If this is a real-life example, feel free to share the stock and time frame. If a hypothetical, I hope I’ve adequately addressed the question.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Real life although it’s way down to 4.00 +/- on my last look on an Oct 18 expiration. If I would have had my new account funded in time I could have taken advantage. Alas still waiting on verification from IB brokers.
MLCO, is the stock.
I am a big believer in value for money spent, and wary of something to good to be true as it probably isn’t.
However as a beginner I’m still not understanding the downside here as the market would have had to crash to devalue this. I constantly search for large premiums in covered calls that will reduce considerably the downside but still give a reasonable return on the stock if exercised. Since I’m not in love w any particular stock I do not fear turning it over.
As always I watch volume, age of company, and welcome volatility. Other then devaluing the underlying I still do not see the risk reward ratio as being upside down. In conclusion it seems that the stock would have to fall dramatically before my premiums could reduce the investment to get hurt, and even w/o selling options that is still the risk inherent to the market.
Thank you for ur imput as I will continue to be on the lookout for suitable candidate’s and hopefully being able to put the Ellman calculator to good use!
Please re-check the premium associated with the $14.00 call. Pre-market this morning for the 10/18/2019 contracts, I see a bid-ask spread of $7.30 -$7.50 on the CBOE site. That puts the time-value close to $0 which makes more sense for such a deep in-the-money strike.
It is possible that the “ask” was $11.50 at some point because the liquidity (open interest) is so low (2 contracts as of this morning) which actually is another reason to avoid this stock for our option-selling portfolios.
Let me know if you have any information to the contrary.
Thanks Alan. 3 more questions if I may.
1. You have the 20/10% guidelines for exiting when the stock goes down. How about when the stock goes up significantly, do you have guidelines when (price and timing) we should do a mid-contract unwind, particularly for options that started deep ITM?
– Also connected to this: if I were to unwind on Monday, should I sell another one for Sep 20, or Oct 18?
2. What are your thoughts on using margin to do covered calls? Especially when margin interest is less than the 2% monthly target for covered calls?
3. How do the 20/10% guidelines apply when you do weeklies? How about when you enter a position in the middle of the month (like next Monday)?
Thanks in advance!
1. The MCU strategy applies to the first half of a contract where the cost-to-close approaches zero and where we can generate at least 1 % more than that cost-to-close with a new position in that same contract.
2. I prefer to work within the same contract.
3. I believe that margin accounts should be reserved for sophisticated, experienced investors. Most retail investors should trade in cash/IRA accounts in my humble opinion.
4. The 20%/10% guidelines also apply to Weeklys. One of the disadvantages of Weeklys is that there rarely is enough time to mitigate losses and enhance gains. This is one of the reasons I prefer Monthlus but we certainly can be successful with Weeklys as well.
I heard you speak recently in San Francisco and got really excited about options. I just finished your beginners series on covered calls which is excellent but one point I don’t get. When the stock moves higher than the strike, why doesn’t the option get exercised so the option buyer can make an immediate profit? Isn’t that why the option was bought in the first place? I hope this isn’t a dumb question!
Hey Toni, welcome to the group! As you know from listening to Alan he’s got this stuff down pat and will give you a great answer.
I can only speak for me but when I buy an option I have zero intention to ever exercise it. I am doing it for upside speculation on the option itself and I hope to just sell it for a profit. Plus a lot of options are bought as part of more complex multiple leg trades which could have staggered expirations.
If I want to acquire a stock I sell cash secured puts below the current market and keep doing that until they finish ITM and my broker assigns it to me. I have missed some great buying opportunities doing that and have felt like I was left standing alone at the station as the train pulled away a few times but at least when I did get filled it was at a price I picked and was paid often multiple times to wait for. And the train has a funny habit of circling back around anyway if one is patient :). – Jay
Jay makes a great point. For the most part, option buyers do not want to be share owners but rather option-sellers. Other reasons in-the-money options aren’t exercised prior to expiration:
1. They can keep the cash in an interest-bearing account until just prior to expiration.
2. Less capital risk until share are purchased, if ever.
3. No rush… they have control of the shares up to contract expiration.
4. More time to re-evaluate bullish assessment.
5. Exercise results in capture of intrinsic-value but loss of time-value.
Bottom line: Exercise, if it occurs, will take place after contract expiration most of the time. Exceptions are generally related to ex-dividend dates.
Wow what great information! Thanks Jay and Alan.
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Alan and the BCI team
I want to ask question about exit strategies.
When developing BCI methodology you use 20/10% rule as starting point to deal with losing trades. When selling CSP you propose 3% rule to exit. So why 20/10% instead of having percentage defined ‘stop loss’ in case CC trade goes against us? It will eliminate such strategies as ‘hit a double’, but it could save us a lot of money if we will cut the loss fast, especially knowing that many stocks that passes BCI screens are growth stocks and they can fluctuate in price dramatically (just to name a few are ULTA, ANET, HQY. They all used to be on BCI reports not so long ago, but now are trading at much lower valuations). I was reading Jack D. Schwager’s ‘Market Wizards’ and many of these traders interviewed in his book say that cutting the loss fast was very crucial to their success. I’m usually very reluctant to close the losing trade and often find myself in situation when I was taking no action hoping for stock to rebound, but the further waiting just resulted in even bigger loss at the end. So I was thinking to take more strict approach to deal with losing trades. Instead of buying the option back when it’s price declines to 20/10% I plan to liquidate the entire position if the stock closes at 5% (or more) below the initial stock purchase price. Despite the price changes the next trading day I plan to buy the option back and sell the stock and use this cash to purchase another stock from the most recent BCI report.
What are the disadvantages of such strategy in your opinion? And why you prefer 20/10% instead of percentage ‘stop loss’ on stock?
The reason we use a 20%/10% guideline range for covered call writing is that we are in 2 positions (long stock, short call) whereas when we sell puts we are only in the short put position. The 20%/10% guidelines will assist in determining when to close the short call and then we can decide on how to manage the other side of the trade.
Now, we do have a 20%/10% guideline range for puts as well but since puts are inversely related to share price, it applies when share price accelerates.
When we close short calls and still own the shares, there are potential opportunities with the same underlying. Let’s focus in on when to sell the shares and move on. This is certainly a viable solution in some cases. In my books and DVDs I propose analyzing why the decline in price (check news) and is that decline significantly under-performing the S&P 500? Not all situations should be treated the same. Was it overall market decline? Then we can’t blame the stock. Was it a single analyst downgrade? Then recovery is likely. Was it corporate fraud? Then, it’s time to get out of Dodge. Selling the stock IS one of our choices (“Convert dead money to cash profits” in my books/DVDs).
Your proposed approach of selling the shares at 5% below purchase price automatically limits our option-selling opportunities. I agree that we must have actions prepared to mitigate losses. That’s what BCI is all about along with enhancing gains. Let’s say we bought a stock for $50.00 and sold the 50.00 call and it drops to $47.00 10 days later. Let’s also theorize that the stock price dropped from negative trade news causing the entire market to decline. We buy back the option based on our 20% guideline. What next?
The 5% proposal will motivate us to sell. OR:
We are in the first half of a contract, we can look to hit a double. If there is no share recovery, we can roll down. If the stock is under-performing the S&P 500, we can close the long stock position. One size does not fit all and, in my view, a better approach than 1 solution to all scenarios as long as we leave ourselves protected to the downside.
Now, when to sell a stock, after other alternatives have been exhausted, has been addressed in this venue many times over the years as many BCI members also have proposed percentile limits on share depreciation. IBD proposes an 8% guideline and up to 10%.
Many of the proposed rules and guidelines we read or hear about relate to stock-only portfolios. That’s not us. We are starting out at a lower cost-basis than investors who only buy and sell stock so those rules may not precisely fit our needs.
To sum up: We should have a multitude of remedies for share decline and some will involve only the option side of the trade and some will involve closing the entire trade. A specific percentage decline sell signal generally ranges from 8% -10% below purchase price (or price when trade was entered). This threshold is not that far from the 5% you propose when we consider the option premium profit.