Portfolio Overwriting is covered call writing using existing long-term buy-and-hold securities. It implies low cost-basis shares, dividend-bearing stocks and exchange-traded funds (ETFs). Since we don’t want our shares called away while generating additional option premium, cash flow decisions must be made on the best strike prices to select for our short calls. What is the basis of these selections? Some may turn to Delta. One of the commonly used definitions of Delta is the probability of the option strike expiring in-the-money. The deeper out-of-the-money the strike, the lower the Delta. So should we select a Delta of 10, 20, 30? One answer lies in our strategy goals.
Defining our goals
There are two goals inherent in portfolio overwriting:
- Increase portfolio returns by selling options
- Avoiding exercise of these options
We want to have our cake and eat it too!
Strike selection clarity can be achieved by first stating our annualized return goals. We may want to increase our long-term portfolio returns by 2%, 4%, 6% or 8% per year, as examples. Once the annualized goals are set, we then check option chains for out-of-the-money strikes that generate these targeted returns.
Real-life example with Facebook, Inc (NASDAQ: FB)
The brown field highlights 1-month expiration strike prices currently $10.00 – $20.00 higher than current market value. The bid prices are $1.31, $0.55 and $0.16 for the $195.00, $200.00 and $205.00 strikes respectively. Let’s next feed these stats into the BCI Portfolio Overwriting Calculator:
The three strikes showed annualized returns of 8.33%, 3.50% and 1.02% as highlighted in the brown fields. By setting annualized return goals before entering a trade, the calculator will guide us to the appropriate strike selection.
Before entering a trade, we must first determine our return goals. Once these are established, strike selection is facilitated particularly when utilized calculators like the BCI Portfolio Overwriting Calculator.
Coming soon: Stock Repair Calculator
In the past few months, several of our members have inquired about the stock repair strategy where options are used to mitigate losses from stock price declines. This is not an income-generating strategy as are covered call writing and selling cash-secured puts. It is a strategy where we use our knowledge of options to lower our breakeven price point for stocks that we own at a higher price than current market value. I will be publishing a blog article to further explain the strategy and provide a detailed webinar on the premium member site. Barry and I have created a calculator that will assist in setting up and managing the 3 legs of these trades (long stock, long call and short calls). Here is a screenshot part of the spreadsheet:
AAII National Investor Conference: Las Vegas Nevada
October 26 @ 8:00 am – October 28 @ 1:00 pm
October 26th – 28th, 2018 (Friday through Sunday)
Alan’s presentations: Saturday October 27th at 9:30 AM and 1 PM (just added)
Visit Alan, Barry and the BCI team in the exhibit hall Friday, Saturday and Sunday
This week’s economic news of importance:
- Case-Shiller home price index July 6.0% (6.2% last)
- Consumer confidence index September 138.4 (133.2 expected)
- New home sales August 629,000 (625,000 expected)
- FOMC projections 2-2.25% (as expected)
- Weekly jobless claims 9/22 214,000 (216,000 expected)
- GDP revisions Q2 4.2% (4.3% expected)
- Durable goods orders August 4.5% (2.2% expected)
- Pending home sales August -1.8% (-0.8% last)
- Personal income August 0.3% (0.4% expected)
- Consumer consumption August 0.3% (0.4% expected)
- Consumer sentiment September 100.1 (100.8 expected)
THE WEEK AHEAD
Mon October 1st
- Markit manufacturing PMI September
- ISM manufacturing index September
- Construction spending August
Tue October 2nd
- Motor vehicle sales September
Wed October 3rd
- ADP employment September
- Markit services PMI September
- ISM nonmanufacturing index September
Thu October 4th
- Weekly jobless claims 9/27
- Factory orders August
Fri October 5th
- Nonfarm payrolls September
- Unemployment rate September
- Average hourly earnings September
- Trade deficit August
- Consumer credit August
For the week, the S&P 500 moved down by 0.54% for a year-to-date return of 8.99%
IBD: Market in confirmed uptrend
GMI: 4/6- Bullish signal since market close of July 9, 2018
BCI: Selling an equal number of ITM and OTM strikes for new positions.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
The 6-month charts point to a bullish tone. In the past six months, the S&P 500 was up 10% while the VIX (12.12) down by 40%.
Wishing you much success,
Alan and the BCI team