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The Significance of Breakeven When Constructing Our Poor Man’s Covered Call (PMCC) Trades: A Real-Life Example with International Business Machines Corp. (NYSE: IBM)

The PMCC Strategy involves buying LEAPS call options (expirations 1 – 2 years out) and selling short-term call options against the long position. The technical term is a long call diagonal debit spread. In our BCI methodology, the trade construction must meet a required trade initialization formula where the difference between the 2 strikes + the initial short call premium must be greater than the cost of the LEAPS option. Adhering to this formula will allow us to close a PMCC trade at a profit if share price rises exponentially and we are forced to close the trade. Another calculation that can be made when setting up these trades is the breakeven (BE) price point. This article will highlight the significance of BE as calculated by the BCI PMCC Calculator.

 

Real-life example with IBM

  • 6/6/2022: IBM trading at $141.35
  • 6/6/2022: The January 19, 2024, $120.00 LEAPS shows an ask price of $29.15
  • 6/6/2022: 7/15/2022, $150.00 call shows a bid price of $1.04

 

Calculations using the

 

 

IBM: PMCC Calculations

Note the following:

  • The initial trade structuring successfully meets our required formula (noted with a bold “YES”) with a positive $1.89 per-share should the trade be closed early due to significant share appreciation. In other words, the trade would be closed at a profit in that scenario
  • The 39-day short call return is 3.57%, 311.11% annualized
  • There is additional upside potential, if IBM moves up the $150.00 strike of 29.67%
  • The total 39-day potential return is 33.24%
  • The breakeven price point is $148.11, higher than current market value
  • What is the significance of this BE price point?

 

How we calculate the PMCC BE price point to be $148.11?

  • Buy IBM at $120.00 and sell at $148.11 = +28.11
  • The cost of the LEAPS is $29.15, less the $1.04 initial short call premium = $-28.11
  • This does NOT mean that IBM must move to $148.11 in order to be a successful trade
  • It does mean that if we close the trade, IBM must be above $148.11 (at that point in time) to be profitable

 

Practical application of the PMCC BE price point in this IBM example

If IBM trades at $148.11 at expiration, with a $150.00 strike in place, no action would be taken, and we would realize a significant 39-day return. With this share appreciation in mind, we would write a higher strike call in the next contract cycle to continue the cash generation process.

 

Discussion

When structuring our PMCC trades, the BE price point represents the share price where credits and debits equal zero should the trade be closed. The price of the underlying security can be lower than the BE price point at expiration and still result in a highly successful ongoing trade.

 

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Your generous testimonials

Over the years, the BCI community has been incredibly gracious by sending our BCI teaemail 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 name unless given permission:

Hi Alan,

Continuing to listen and learn from your tutorials.

As I said a couple of months back when we had talked on the phone, your plan is the best I have come across. More importantly, it seems that your videos truly strive to help with options education.

Thanks for the step by step on-line learning as I work to develop a strategy integrating your system into a dividend-based plan.

Jon

 

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1. Mad Hedge Traders and Investors Summit

Thursday December 8th at 12 PM ET (registration link to follow)

Free virtual webinar

Covered Call Writing: Multiple Applications Based on Current Market Conditions

Real-life examples with Invesco QQQ Trust (Nasdaq: QQQ)

 Covered call writing is a low-risk strategy geared to generating cash-flow with capital preservation as a key requirement. This presentation will demonstrate how the strategy can be crafted to succeed in all market environments.

Market situations highlighted are:

  • Normal-to-bull markets
  • Bear and volatile markets
  • Low interest rate environments

This webinar will include specific methods to set up ultra-low-risk paths to set up trades with 84%+ probability of success.

 

2. Long Island Stock Traders Meetup Group (Private webinar)

Analyzing a 1-Month Covered call Writing Portfolio from Start to Finish

Thursday February 16,2023

7:30 PM ET- 9 PM ET

A real-life example with a $100k Select Sector SPDR portfolio
Covered call writing is a low-risk strategy that generates weekly or
monthly cash flow. This presentation will demonstrate how to implement this
strategy using a database of only 11 exchange-traded funds for a 1-month option
contract cycle. These are real-life trades taken directly from one of Dr. Ellman’s
portfolios with screenshots verifying each trade. A final monthly contract result
compared to the performance of the will be calculated.

Topics included in this webinar:

 What are the Select Sector SPDRs?
 How to establish a covered call writing portfolio
 What is the role of diversification?
 What is the role of cash allocation?
 Calculating initial returns
 Analyzing each trade in the monthly contract
 Final results
 Next steps

 

Alan speaking at a Money Show event

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Market tone data is now located on page 1 of our premium member stock reports and page 1 of our mid-week ETF reports.

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

6 Responses to “The Significance of Breakeven When Constructing Our Poor Man’s Covered Call (PMCC) Trades: A Real-Life Example with International Business Machines Corp. (NYSE: IBM)”

  1. Barry B November 26, 2022 11:20 pm
    #

    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 11/25/22.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them on The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:

    http://www.youtube.com/user/BlueCollarInvestor

    Reminder: Premium members are grandfathered into your current rate and will never see a rate increase as long as the membership remains active.

    Best,

    Barry and The Blue Collar Investor Team
    [email protected]

  2. Jeff November 27, 2022 5:45 am
    #

    Alan,

    I have a few covered call trades (December 16 expirations) where I sold OTM strikes that are now ITM because the price of the stocks went up.

    Is it too early to roll out and up to allow the stock price to continue to go up or is that being too aggressive.

    I love the new TMC calculator but not sure if an exit trade is called for here.

    Thanks,
    Jeff

    • Alan Ellman November 28, 2022 6:23 am
      #

      Jeff,

      When share price accelerates significantly, leaving the (once OTM) strike now ITM, the strategy to consider (early in a monthly contract) is the mid-contract unwind (MCU) exit strategy. It is too early in the contract to consider rolling-out-and-up.

      We can use the “Unwind Now” worksheet tab at the bottom of the Trade Management Calculator System to determine the time-value cost-to-close. This will guide us as whether to move forward with the MCU.

      For detailed information on the MCU strategy, see Chapter7 (pages 29 -34) of my latest book, “The Blue Collar Investor’s Guide to: Exit Strategies for Covered Call Writing and Selling Cash-Secured Puts”.

      Alan

  3. Cornelius November 27, 2022 2:46 pm
    #

    Dear Alan,

    Prior to subscribing to Investors Business Daily I went through some charts and came to BTU – Peabody Energy Corporation. Just concerning the technicals, I would open a position to sell calls on this stock, but did I interpret the technicals correctly that they all show bullish signals? I attached the screenshot from tradingview.

    Also, I have another question concerning the oscillator. At one point in your book you wrote that when the oscillator crosses the 20%-Line you consider it to be a buy-signal. But in the afore mentioned example BTU the oscillator is near the level at which the stock is supposed to be overbought. Is it consistent with the BCI methodology to buy stocks when all other indicators are giving a buy-signal but the oscilllator is near or above the 80%-level?

    Best regards

    Cornelius

    Neu-Ulm, Bavaria

    CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.

    • Alan Ellman November 28, 2022 6:35 am
      #

      Cornelius,

      I agree, this is a bullish chart pattern.

      Now, regarding the stochastic oscillator:

      When the oscillator moves above the 20%, we have a bullish signal, not necessarily a buy signal.

      When the oscillator approaches or even moves above the 80%, we are still good. I have seen stocks remain in “overbought” territory for months. However, if the oscillator drops from above 80% to below 80%, we have a bearish signal and if it returns and dips below 80% for a 2nd time, we have a more meaningful bear signal.

      Reading price charts is an art as much as it is a science and open to multiple interpretations. I am sharing mine and agreeing with yours.

      It is also important to remember that technical analysis is a critical aspect of our screening process, but only 1 of the 3 major screening categories (fundamental analysis and common-sense principles are the other 2).

      BTU is an excellent candidate based on technical analysis. The reason it did not earn its way onto our latest premium member stock report is that it fell a bit short in the IBD Smart Select Rating analysis (see arrows in the screenshot below).

      Your analysis of the technical chart is outstanding.

      Alan

      CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.

  4. Alan Ellman November 30, 2022 5:16 pm
    #

    Premium members:

    This week’s 5-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, mid-week market tone as well as the implied volatility of all eligible candidates.

    New members check out our ongoing and never-ending training videos (“Ask Alan” and Blue Hour webinars). We add at least one new video each month. Only premium members have access to the entire library of these training tools.

    For your convenience, here is the link to login to the premium site:

    https://www.thebluecollarinvestor.com/member/login.php

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    Alan and the BCI team