You write a covered call on a stock trading at $165.00 and sell the $170.00 call option. A few days later, your stock is trading at $28.00 and the strike you sold no longer appears on option chains. What do we do? Panic? Curl up into the fetal position and feel sorry for ourselves? Research the matter and respond in a non-emotional manner? So much for the rhetorical questions.
In August 2017, TAL Education Group (NYSE: TAL) was a stock listed on our Premium Member Stock Report at a price of $165.60. On August 16th the listed price was $28.00. The strike prices for options associated with this security were also much lower than they had been prior to the 16th. The first explanatory event that should come to mind is a stock split.
TAL Education Group- 6-for-1 stock split
TAL: 6-for-1 Stock Split Contract Adjustments
By speaking with our brokers, checking CBOE.com/contract adjustments or simply googling “TAL/stock split” we will access the information highlighted in the screenshot above:
- TAL underwent a 6-for-1 stock split on 8/16/2017
- For every 1 share owned, the holder now owns 6 shares
- Share price is reduced to 1/6 its previous value resulting in no change in total value
- Strike prices are also divided by 6 so the $75.00 strike becomes a $12.50 strike
- Had we sold 1 $170.00 call option, that will change to 6 contracts of the $28.33 strike
The key takeaway is that there is no change in value of our total position, either positive or negative. Stock splits are maneuvers by Boards of Directors to lower share price and allow retail investors the opportunities to purchase shares in 100 share increments. Another example is when Apple Computer was trading over $700.00 per share and then split 7-for-1 (where are you Google and Amazon?).
TAL updated option chain
TAL Post-Split Option Chain
Had we sold the $170.00 pre-split call, the new option chain will show the $28.33 ($170.00/6) strike with a bid-ask spread of $1.15 – $1.35. These are now the prices we refer to when managing our new positions (we now are responsible for six times the number of short contracts).
Discussion
All trading and investment strategies must be managed non-emotionally. When share price drops dramatically and strike prices disappear from option chains, the first event that should come to mind is a stock split that will result in contract adjustments. These corporate events will not add to or detract from our portfolio value but rather must be managed from a new perspective. Panic and fear should have no place in our position management arsenal.
Why show stocks with inadequate open interest in our premium reports?
This is a question that has come up quite a bit lately. The reasons are:
- Open interest can change after the report was produced
- We have many members that use these reports for buying and selling stocks without the option component and so open interest is not a factor
Below is a screenshot of where open interest is located in our member reports (Y means more then 100 contracts and N means less than 100 contracts for near-the-money strikes):
Open Interest and the BCI Premium Stock Reports
Upcoming speaking events
POINT, or Phoenix Options Investors Networking Traders,
Friday March 2, 2018 6:30 PM to 9:00 PM Rio Salado Community College 2323 West 14th Street · Tempe, AZ
American Association of Individual Investors: Phoenix Chapter
Saturday, March 3, 2017 9:00 AM Registration/Social Time 9:00 AM Refreshments Time 9:30 AM Program Time Location: Jewish Community Center 12701 N. Scottsdale Road Scottsdale, Arizona 85245 DIRECTIONS: The Center is 3.66 miles south of 101 on Scottsdale Road. The Center is on the left as you drive south from 101 OR Take 101 to E. Cactus. Drive 2 miles west on E. Cactus to N. Scottsdale Rd. Turn right on N. Scottsdale Rd. The Center is 1/8 mile on…
Portfolio Overwriting webinar for The Options Industry Council (OIC)
Date: 3/22 @ 2 PM ET
FREE Registration Link:
https://event.on24.com/wcc/r/1601761/6C464B87CD0C7A4ADA711D117EED7372?partnerref=presenter
Market tone
This week’s economic news of importance:
- Manufacturing PMI Feb 55.9 (55.4 expected)
- Services PMI 55.9 (53.8 expected)
- Existing home sales Jan 5.38 million (5.61 expected)
- FOMC minutes Jan 31st
- Weekly jobless claims Feb 17 222,000 (229,00 expected)
- Bloomberg consumer confidence 56.6 (last 57.0)
For the week, the S&P 500 rose by 0.55% for a year-to-date return of 2.76%%
Summary
IBD: Market in confirmed uptrend
GMI: 3/6- Buy signal since market close of February 20, 2018
BCI: Market volatility (VIX) has dipped under 20, a positive. If this trend continues, I plan to take more aggressive stances on my positions. Currently, I hold an equal number of in-the-money and out-of-the-money strikes and remain fully invested.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
The 6-month charts point to a neutral outlook. In the past six months, the S&P 500 was up 14% while the VIX (16.49) moved up by 39%.
Wishing you much success,
Alan and the BCI team
Alan,
Regarding the IBD 8-10% guideline, if the share price has fallen 8-10% due to, say, panic selling in the market (i.e. a non-company specific event), do we still buy back the options at any price and sell the shares as per this guideline of 8-10% or do we roll down to an OTM strike to mitigate our loss in the hope that market will rally?
Thanks,
Duminda
Duminda,
In the scenarios when most shares decline due to overall market decline or “panic-selling”, we always buy back the option using the 20/10% guidelines. At that point, we roll down to out-of-the-money strikes to begin the process of mitigating losses. The process of option-selling continues to lower our cost basis.
Exceptions to this guideline would be when we have market aberrations like we last experienced in 2008 when we may opt to close all positions until the market recovers. These occasions are extremely rare.
Alan
Hey Alan,
If we had to put titles on our blog posts this one would be “Suspicions of a Cynical Hobbyist” 🙂
Does it seem to you or anyone else that the computer programs are running the market to an ever increasing degree?
Most days this week before yesterday they ran the market up in the morning and down in the afternoon for a negative close on light volume. I suspect that may have created an increase in short interest which they saw yesterday so they ran the market up a bit, that caused short cover buying and we had a great up day on half the average daily volume on SPY, less than average volume on DIA and only a slight volume uptick on QQQ.
Conventional wisdom suggests a meaningful breakout is when a resistance level is breached on high volume. That is not what happened yesterday. It looked to me like a computer generated short squeeze. And now that many shorts bought back to close at a loss to the house the machines will take their profits early in the week with much less short exposure to pay when they take the market back down?
If you are paranoid like me you only have to be right once :)!. Just curious if you, Barry or anyone else suspects the same thing and if mine is a reasonable assessment? – Jay
Jay,
We should always be on the lookout for the type of hanky-panky you are concerned about but I am (my personal opinion) less inclined to believe in these conspiracies since the watchful eyes of the SEC and FINRA have sharpened significantly after the market collapse in 2008 and the flash crash in 2010. The reason I trade predominantly between 11 AM and 3 PM ET is to avoid the early morning and late afternoon volatility created by institutional computerized trading.
Alan
Thanks Alan, as always your reply makes good solid sense. And as you likely suspected and I signaled with the smiley faces my post was part tongue in cheek! There could be many legitimate free market reasons why the tape is all over the place on light volume.
Still when you read about big houses “running the stops” and those sorts of things at least my adult skepticism kicks in from time to time. You and Barry please have a great new week! – 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 02/23/18.
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
Best,
Barry and The Blue Collar Investor Team
barry@thebluecollarinvestor.com
I am re-reading the exit strategy chapters in the Complete Encyclopedias and was wondering if you ever roll up in the same contract month? All the examples are for rolling out and up to the next month.
Thank you.
Marsha
Marsha,
In my traditional covered call writing portfolios, I rarely roll-up in the same month. I do watch carefully for a “mid-contract unwind” exit strategy opportunity. As expiration Friday approaches, based on stock and overall market assessment, I may roll-out-and-up.
Now, if using the long call diagonal debit spread (Poor Man’s Covered Call), the roll-up in the same month is in play (and will be part of our new PMCC Calculator), since we are making a long-term commitment to the underlying.
Alan
I am a new Premium Member. Can you please tell me what website Alan uses for option chains? The one he uses looks simpler than some that I’ve looked at.
Jon
Jon,
In most of my books and DVDs, I used option chains from Investools toolbox which is no longer available.
Lately, I have been using option chains from:
http://www.finance.yahoo.com
and
http://www.cboe.com
Alan
Members, beware of Ernings Reports !!!!!
CGNX was confirmed to report on 02/15 after the bell.
I sold my 200 shares at a 14% loss, aprox. $4,000.00 at 3 o’clock. Tough decision. 🙁
At 4:30 CGNX dropped 11% after POSITIVE Ernings.
It recovered a bit the next morning, settling at an 8% drop to this day.
So I avoided a bigger loss.
OLED was confirmed to report earnings on 02/22 after the bell.
I sold my 200 shares at a small gain of 1.5% in the morning of that day.
OLED dropped more than 15% after POSITIVE ernings.
So, here again I avoided a big loss.
Market reaction after Earnings Reports is unpredictable.
Roni
Great information, Roni. Nice to see feedback regarding exiting a position with upcoming Earnings.
I am holding ROST (ROSS) myself and Earnings verified are on 3/6. Right now I am 5.5% below breakeven. The price chart is currently rising and hopefully I will be able to reduce further my losses before selling the stock.
I also have several ETF’s below breakeven. Current account value of my portfolio is down 4.6% from the peak value it had around 1/26/18.
Mario
Roni,
I also “rolled out” from stock two positions after Expiration Friday by adding the option leg.
FIVE (Five Below) and TSS (Total System Services) both were 20/10% Exit Rule stocks from last month. They rose to last month’s entry sell prices on week 1 of this cycle and now have net gains of 8.75% and 4.01%, respectively from cost basis.
Mario
Roni;
Do you also have TOL? ER is Tuesday before the bell.
Best;
Terry
Terry,
yes, I do have TOL and forgot about ER today.
Thanks for reminder.
Roni
Well done Mario.
Hey Roni,
That is very interesting stuff, thanks for sharing. We all know earnings reports are pivotal short term moments for most stocks so as a minimum switch to weeklies to hop scotch the event and NEVER be covered during a report and miss the often big upside that can occur.
My opinion is if you like a stock’s fundamentals, have had it a while and it is in a cash account you don’t necessarily need to sell it before earnings and create a tax event. But if you do your covered call trading as a primary cash flow/income producer in an IRA account and stocks are just month to month cash flow/income vehicles to which you have no attachment then it makes all the sense in the world to get out of them before earnings and move on to another one.
I used to do that. I frankly grew weary of the process and now hold ETF”S selling calls selectively. There is no where near the premium of using higher beta stocks but this game is always a balance between potential returns, investing horizon, risk tolerance and the time and energy you want to put into it. -Jay
Jay,
I do as you say only monthly “cash flow/income producing”.
Also, I believe ER are a 50/50 bet or worse, so I learned not to gamble.
Roni
Alan.
Last week I signed up for the premium membership. Working through the learning curve. Reading “Exit Strategies”.
Quick question – do we seek to get better pricing on “option buy back” by using limit order at he middle of the spread just like we do when first sell the call option?
Thanks,
Rama
Rama,
Yes, leveraging the “Show or Fill Rule” works both ways. In the case of a buy-to-close, the limit order is placed slightly above the mid-point of the spread.
Alan
Thanks Alan.
Similarly when buying and selling the stock can ‘show or fill’ rule be used to create limit orders for better price execution?
Rama,
Yes, limit orders placed between the bid and ask prices can be used for stock buy and sell orders.
Alan
Alan,
Are you still using the USAA Brokerage Services? or are you using other online discount brokerage?
Also, is there any specific online discount brokerage you recommend?
Thanks,
Byung
Byung,
Yes, I am still using USAA. This is a product of the fact that I was an officer in the military and started using all their products (insurances, brokerage etc.) and have remained loyal to these associations. USAA is very good but not the best. You can find brokerages that offer trades at lower commissions.
Check out the online discount brokerage file in the free resources link on the top black bar of these web pages.
Alan
Let us say, at the beginning of the February contract cycle, I bought 100 shares of XYZ at $20 per share and sold $22 OTM strike at premium of $0.50 (ROO= $0.50/$20=2.5%). On expiration Friday, the share price has fallen to $19.25 and the options expire worthless. Let us also say that the earnings report is due during the March contact cycle. Further, the fundamentals of the company hasn’t changed and the technical indicators show a mix-picture (share price has fallen but not dramatically).
Are we going to sell the shares at a loss of $0.25 per share (0.75-0.50) OR are we going to keep the shares and wait for the earnings report to pass?
Thank you.
Duminda
Duminda,
The $0.25/share loss plays no role in this decision. I will hold a stock through an earnings report rarely but only when the stock has historically out-performed market consensus. In the past few years more stocks positively surprise because guidance has been muted. But there is always risk of a disappointment.
Generally, these stocks are sold in our covered call accounts prior to the report. There are exceptions when we hold through the report and write the call after the report passes.
Alan
I have been a member now for six months. It is the best financial decision I’ve ever made. During this time I’ve taken advantage of numerous opportunities to role out, up, and occasionally down with great success. I do have one nagging question. Why is rolling out/up a better financial decision than simply having your ITM shares called away and then buying the shares back the following week and writing a new call? There always seem to be some time value left that you have to surrender when rolling out.
Douglas,
If options are rolled on or near expiration Friday, the time value component will be pennies, assuming the volatility of the underlying isn’t off-the-charts.
If the calculations meet our goals and we want to keep that stock in our next month’s portfolio, rolling makes sense. The few pennies of time value we will spend are compensated for by the one less trading commission we incur by rolling rather than allowing assignment and re-buying the stock and selling the next option. Also, in some cases, we will be receiving one more day of time value for the new option.
Alan
Douglas and Alan,
Regarding Rolling out/up versus letting assignment occur and writing a new covered call on Monday after Expiration:
I have accounts with Fidelity and Etrade;
Rolling:
Fidelity: Rolling $4.95 commission plus contract @$0.65 combination order
Etrade: Rolling $4.95 commission plus contract @$0.50 combination order
Assignment on Friday and Buy-Write Covered call next Monday:
Fidelity: Assignment 4.95 + Covered Call Combination (4.95 + $0.65 per contract = 9.80 + contracts
Etrade; Assignment 4.95 + Covered Call combination (4.95 (stock) + 4.95 (option) plus 0.50 per contract = $14.85 + contracts (Etrade charges the base commission for each leg – that’s their policy)
So the difference is mainly 1 commission with Fidelity and 2 commissions with Etrade.
On other advantage (in addition to the time value) of rolling is that if the stock appreciates significantly on Monday before your order is filled, you have lost some ROO% profit. It is also nice to see your trade ROO% accumulate to higher returns and your Breakeven cost basis point is reduced when you have a credit roll.
Mario
Alan,
I started trading, stocks only, with PCFN using Prodigy internet connection. Seems like decades ago. Have stayed with them through DLDJ, Harris etc. through to Etrade. I noticed BCI lists E-trade @ $6.95 per Equity trade and $6.95 plus $0.75 per Contract on Options.
I have been paying $4.95 per Equity trade and $4.95 Plus $0.50 per contract on Options for several years. I recently had a grand son-n-law open a small account with them and he got the same rates. I had recommended him, to get a bonus which I gave to my grand son-in-law.
E-trade also has a dime buyback program which is commission and fee free.I have used it several times when options I had sold dropped to or below $0.10 just before expiry allowing me to more easily “hit a double”, a term I learned from you.
E-trade has also purchased OptionsHouse or their trading platform as it is now on E-trade.
I realize the commissions and fees are not the cheapest but I have become so accustomed to using their research tools and trading platforms that I guess I am too lazy to try a cheaper discount brokerage firm. Although Schwab seems to be giving everyone but Interactive Brokers a run for their money.
I assume all brokerage accounts are settling equities in two days and options in one day.
Hoyt
Hoyt,
Thanks for sharing. Hard to believe that we actually paid $50 – $200 per trade decades ago.Brokerages are lowering rates as competition for our trading dollars continues to heat up. Many industry experts have told me that we are headed to zero commissions with brokerages making profits from bid-ask spreads…we’ll see about that.
Alan
Alan,
In determining the price to sell your deep ITM strike, do you aim to obtain some time value?
Thanks,
Jake
Jake,
Yes, time value represents our initial option-selling profit. Since our goal is to generate monthly cash flow, time value is essential.
We must define our initial monthly (or weekly) time value return goals (my parameters are 2-4% per month, up to 6% in bull markets). Then we check option chains for ITM strikes that meet these goals.
Alan
Alan,
In the last two year low volatility bull market I have done very well with LEAPS. Financials(particularly BAC), FB, WMT, HD, TSN, CAG, etc.
After signing up for BCI’s Premium service new worlds and thinking have opened up to me. Using the BCI Covered Call management system has opened my eyes to more active trading of Calls that I write. I often trade several times before Expiry.
This has made me rethink how long to keepWhat have noe become DTM Calls (not Covered Calls) before I sell them. At some point the delta begins to approach 1.0 so the ROI is still excellent but I wonder if I am beginning to reach a point of diminishing returns.
I have tended to only pay much attention to Delta and have basically ignored Gamma. But I am beginning to think I may have missed a nuance that could have improved my profitability. It appears to me that Gamma on LEAPS is more important in low volatility markets as the stock price approaches the strike price. I’m wondering if Gamma can give us a better OTM strike price to purchase.
Having said all this, I am also about keeping it simple. But your management system caused me to think differently about how I handled Covered Calls, to my advantage! So I am now thinking about improving my profitability on Leaps.
Any thoughts?
Hoyt
Hoyt,
Welcome to our BCI community. I’m pleased we are playing a role in your portfolio success.
When buying deep-in-the-money LEAPS for purposes of using the Poor Man’s Covered Call (PMCC or long call diagonal debit spread), it is always best to enter the trade in a low volatility environment. This enhances our opportunities to benefit from an increase in volatility when the option is sold or rolled.
Getter deeper in the weeds with the option Greeks is beyond the scope of this site but I’m happy to include a chart I created for my E-Book, “Analyzing the Option Greeks for Retail Investors”
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG
Alan
Thanks, Alan.
Confirms what I was thinking.
I haven’t used LEAPS for Covered Call selling although since viewing your video I have researched several scenarios but couldn’t find one to enter that fit your criteria.
I have used buying LEAPS as proxies for stock ownership. I buy OTM and hold them for various time frames depending on how the underlying stock performs.I had never even thought about selling short term Calls against them when they became DTM. That has been an unexpected benefit from BCI.
I have several positions that makes PMCC an attractive option without having to pick a LEAP position to enter. Having several that have large built in profit cushions gives me options I didn’t know I had.
I really appreciate the added education I have received in this short time of being a Premium member.
Money well invested!!!
Thanks, again.
Hoyt
Hoyt,
Since you are holding DITM LEAPS, selling short-term calls against these positions is definitely a way to generate additional income. It will require a bit more management but should be worth the efforts.
The PMCC is generally promoted as the same strategy as traditional covered call writing but with a lower cost basis. This is too simplistic a definition as there are many moving parts in the strategy which must be understood and mastered before executing. Like all strategies there are pros and cons. Look for a detailed analysis of the PMCC in our new upcoming book, “Covered Call Writing Alternative Strategies” (we’re getting closer).
Glad we are able to expand your investment opportunities.
Alan
Premium members:
The March edition of your Blue Chip Report (Dow 30) has been uploaded to the member site in the “resources/downloads” section (right side of page).
Alan
Alan,
I noticed that in this week’s ETF report, there are some ETF’s which do not have any corresponding option prices even for at the money or near the money strike prices for us to be able to write covered calls. XME is one example from Yahoo finance. As you know, the March expiration Friday is the 16th but I could only find option prices for 29 March in yahoo finance. Please explain why?
Thanks
Duminda,
I have noticed that, from time-to-time, Yahoo Finance will be missing some option quotes as is the case here. When this occurs try:
http://www.cboe.com
Look for (delayed) quotes.
See below for the March 16th option chain for XME as of market open this morning.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG
Alan
Premium members:
This week’s 8-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site. The report also lists Top-performing ETFs with Weekly options as well as the implied volatility of all eligible candidates.
New members check out the video user guide located above the recent reports.
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
Premium Members,
This week’s Premium Member Report may be late this weekend.
I just got an emergency alert from my township saying that the area is expecting very high winds, heavy rain, and possible heavy snowfall. The warning went on to say that there is a potential for power loss due to down trees/power lines.
Best,
Barry