I sell predominantly 1-month options when selling covered calls. This decision was NOT based on anything I read or was told, but rather on experience and common sense. Most stocks with options have at least four expiration cycles affiliated with them at any point in time…the current month, the next month and two more months further out based on the particular option cycle that the equity has been assigned to. Stocks that also have LEAPS (long-term options) have more than four cycles. Add to that the newer weekly and quarterly expirations and we have a lot of options to choose from. Using the options chains and The Ellman Calculator, I will make my case for selling mainly 1-month options (weeklys are also currently being studied by the BCI team as more equities are being added to the “weekly pool”).
Three Reasons to Sell One-Month Options 
1- It facilitates adhering to a core BCI guideline of never selling an option in a contract cycle that has an upcoming earnings report. Since earnings reports are made public on a quarterly basis for U.S. companies, selling short-term options allow us to move our stocks in and out of our portfolios (yet keep them on our watch lists if they still meet our system criteria).
2- Stocks have no loyalty to us. They can be our best friends one month and our worst enemies the next. Although we do have exit strategies to help control a negative situation, the shorter the commitment we have to an equity, the less risk we incur.
3- We make the most money selling one-month options. I’m sure I have your attention now, so allow me to demonstrate via an options chain for Netlogic Microsystems (NETL), trading at the time of this writing for $53.22 as shown in the chart below:
- NETL price
The option chain is shown in the chart below:
- NETL Options Chain
This information was captured after the February contracts expired. We will hone in on the March (one-month out), April (two-months out) and July (five-months out) contracts. Here is the information we glean from the options chain and will feed into the Ellman Calculator (single tab):
- The stock was trading @ $53.22 so we will look at the out-of-the-money $55 call options
- The March $55 call returned $1.65/share (red circle)
- The April $55 call returned $2.55/share (blue circle)
- The July $55 call returned $4.70/share (green circle)
It may be tempting to opt for the higher dollar returns of the longer-term options; however we must factor in the time frame and logically deduce how to best put our money to work so as to generate the most profits. So let’s feed this information into the single tab of the Ellman Calculator, as illustrated below:
- The Ellman Calculator
Now, in the chart below, let’s examine the results of these calculations:
- Option calculations: NETL- 1, 2 and 5 Month Returns
The ROO (initial option returns) or percentage returns generated does NOT include the upside potential. Although the Ellman Calculator does give this information, I left it out of this graphic because all choices have the same upside, and I want to concentrate just on the initial option profit. Here are the ROO figures derived from the Ellman Calculator:
- The March $55 call returns 3.1% (green arrow)
- The April $55 call generates 4.8% (blue arrow)
- The July $55 call generates 8.8% (red arrow)
Once again, upon first glance it appears that the July $55 call will be the most lucrative for us until we annualize these percentages. To do so, we must convert these figures to a monthly return and multiply by 12, as follows:
- March: 3.1%/1 x 12 = 37.2%
- April: 4.8%/2 x 12 = 28.8%
- July: 8.8%/5 x 12 = 21.1%
The one-month options outperformed the two-month options by more than 29% and the five-month options by more than 76%! I rest my case.
***For a FREE copy of the Ellman Calculator and user guide send me an email @: alan@thebluecollarinvestor.com
Include your name and email address with the words “request Ellman Calculator”. The calculations are precisely the same as described in my books and DVDs.
NEXT LIVE SEMINAR:
April 20th in Atlanta. Those who received an email stating the next presentation on 3-21 please note that this event already passed.
Market tone:
This week the S&P 500 surpassed its previous record high from October, 2007. The positive market forces are supported by strong corporate earnings, positive weekly economic reports (outlined each week in this blog), strengthening housing stats and increasing employment figures:
- 4th quarter GDP was revised upward from (-) 0.1% to +0.4% due to better-than-expected business spending and exports
- Real GDP growth for 2012 came in @ 2.2% more than the 1.8% for 2011
- The Conference Board’s index of consumer confidence (a gauge of consumers’ attitudes about the present economic situation as well as
their expectations regarding future conditions. Consumer confidence tends to have a strong correlation with consumer spending patterns) dipped by 8.3 points to 59.7 in February. This appears due to the uncertainty created by the recent sequester - Durable goods orders (a measure of the number of orders for a broad range of products—from computers and furniture to autos and defense aircraft—with an expected life of at least three years. Durable-goods orders are a leading indicator of industrial production and capital spending. Data fluctuate widely from month to month and are often subject to significant revision) increased by 5.7% much higher than the 3.8% anticipated
- Initial jobless claims for the week ending March 23rd came in at 357,000 higher than the 340,000 expected
- New home sales in February came in at an annualized rate of 411,000 representing the second time sales were above 400,000 since April, 2010. This represents a 12.3% rise from the year earlier
- The 4.4 month supply of new homes at current sales rates are near historical lows
- The median price of new homes rose by 2.9% year-to-year to $246,800
For the week, the S&P 500 rose by 0.8% for a year-to-date return of 10%, including dividends.
Summary:
IBD: Confirmed uptrend
BCI: Moderately bullish (love the housing news!) but remaining cautious as the impact of the sequester is difficult to quantify. This site is still slightly favoring in-the-money strikes.
Happy holidays to one and all,
Alan and the BCI team (alan@thebluecollarinvestor.com)
Premium Members,
The Weekly Report for 03-29-13 has been uploaded to the Premium Member website and is available for download.
In an effort to constantly improve our service, we have enhanced the first section of the Weekly Report. We have added the Risk/Reward numerical rank in place of the “Pass Risk/Reward – Yes/No”. The ranking is on a 1 to 10 scale, with a passing rank of 5 or greater. Having the actual rank will aid in your stock selection…especially with stocks that have mixed technicals.
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 BCI YouTube Channel link is:
http://www.youtube.com/user/BlueCollarInvestor
Best,
Barry and The BCI Team
Barry, your addition of the risk/reward ranking numbers gave me a good reason to go back and refresh my memory by re-reading the users guide and to go to their website and re-look at their explanation of how they come up with the risk/reward numbers. This led me to two questions.
First, when you originally just included pass/fail in your report, this implied you didn’t think there was enough of a difference between a 5 and a 10 to use it in our trading decisions. However, by now including the numbers, does this imply that you’ve changed your mind about this and there may well be enough of a difference that we should factor it into our decision-making process?
Second, even after going to their website and reading about their ranking process, I’m not sure I really understand it so that makes me a bit hesitant to use it as a criteria. Could you perhaps shed some more light about how they come up with their numbers and the resulting importance of different risk/reward ranking scores?
Thanks.
Steve
Hello Steve,
Good to hear from you again…
Your first question:
We have had a large number of requests to add this capability as another tool to help in stock selection.
For the typical case (if there is ever a typical case), as you noted, passing the screen is usually enough. This was and is still a key component of Alan’s system. However, some traders, based on their risk profile, feel more comfortable with an additional metric to help them choose from among stocks in the same category, i.e. “Passed All Screens” or “Mixed Technicals”. Hence we added the ability to have the screen provide “finer” results.
This does not imply that the system is modifying the methodology. It is only providing another level of tuning the system to the subscribers level of risk. I personally review at the chart as the “tie breaker”.
Your second question:
MSN uses a proprietary methodology they license from another source. It does not publish the details of how it uses a combination of fundamental and technical factors to determine its’ ratings.
Alan began using StockScouter early on in his development of the methodology to provide an additional, unbiased view of the specific stock and then use the confluence of sources (IBD, StockScouter, the chart, etc.) to accept or reject the stock. This way, multiple independent sources need to “agree” on the quality of a specific stock.
His system was based on using as many free services as possible to keep the traders cost low, MSN StockScouter had and continues to have a very large number of followers…and remains free.
Best,
Barry
Alan, your article about the advantages of monthly options makes me ask the obvious question about weekly options. Seems like they would have the same advantages over monthlies as a monthly would have over a quarterly or a leap.
I think I recall many months ago you answered a question by saying you were going to experiment with weeklies because you didn’t have enough/any data at that time to recommend or not recommend them.
I’m curious what you’ve learned. When a stock or ETF makes your report that has weekly options, think we will get the same advantages with weeklies over monthlies as the ones you describe in this article?
Thanks.
Steve
Steve,
I firmly believe that weeklys WILL have a place in our BCI methodology. The screening process will be precisely the same so as a result we have been monitoring our watch list over the past several months to get an idea as to how many securities pass our screens and have weeklys. Thus far that number is NOT sufficient to populate an adequately sized watch list. As you know, weekly products are being added by the exchanges every week due to consumer demand. In the near future, we plan to add another product for our premium members with a list of securities eligible for cc writing with weeklys.
That being said, I still like monthlys the best because it requires less monitoring that weeklys and allows appropriate time for exit strategies, a pillar of the BCI methodology. However, for those members willing to invest additional time for the potential of slightly higher returns weeklys may be a useful choice.
BTW: We currently list weekly choices in our ETF Reports, usually 4-5 each week.
More to come….
Alan
Alan,
Thanks for the calculator. It looks like a great tool for covered call writing. My question is when you use the multiple tab versus the single tab. Thanks for your assistance.
Linda
Linda,
The “single” tab is best suited when evaluating the various strike prices for a single security. The “multiple” tab is used for evaluating dozens of stocks and multiple strike prices.
Alan
Running list stocks in the news: EVR:
Evercore Partners, a boutique investment banking firm was founded by Roger Altman, a former US Deputy Treasury Secertary in the Clinton administration. From 2007-2009 EVR posted losses but turned that around with profits of $0.95, $1.48 and $1.78 per share in the next 3 years. Revenues increased by 11%, 45% and 21% in the past 3 years. Analysts are expecting EPS growth of 28% and sales growth of 14% in 2013. Pretax margin (18.8%) and ROE (18.7%) both reached 6-year highs last year. Our premium running list shows an industry rank of “A”, a beta of 1.37 and a % dividend yield of 2.10%.
Alan
Hi Allan,
Would it be more realistic to calculate % return based on 8 months rather than 12 months since we skip trading options for a stock 4 times per year when earnings are announced? So instead of March 37.2%, April 28.8%, July 21.1% it would be March 24.8%, April 19.2%, July 14.1%? Or you do sell shares of the traded company utilizing cash on another company (opportunity) that does not have earnings that month? I assume most call writers would be holding companies long-term collecting dividends and share price annual rise…?
Petkus,
You are 100% correct that we must avoid using stocks when earnings are about to be reported. However, there are always solutions to challenging scenarios.
My portfolios turn over 20% to 80% due to earnings and screening results. We have no loyalty to stocks or ETFs if they no longer serve our best interests.
In the case where we are using low cost-basis, dividend-bearing stocks in non-sheltered accounts and we want to retain these securities for the long-term, there is usually a solution here, as well.
Most of these stocks have weekly options associated with them. If an earnings report is due in the 3rd week of a 4-week contract, we write weekly in weeks 1 and 2, skip week 3 and write another weekly in week 4. Then we return to monthlys for the next contract cycle.
Investing is not a perfect world but there are always best solutions.
Alan