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Timing Our Covered Call Trades: The Best Time to Sell Our Options After Buying the Stock

The goals of covered call writing include generating monthly cash flow and preserving capital. We use every fundamental, technical and common-sense principle available to maximize our profits and protect our cash. Paul A. previously sent me an excellent question that motivated this article:

…if the market has a down day and drags down the price of the stocks I am interested in, is it reasonable to buy the stocks and wait a few days in hopes the market will tick back up and allow me to generate higher option returns?

You can tell from the inquiry that Paul is a seasoned investor. Frequently, the overall market direction will cause a price decline in outstanding performing stocks and should the market recover, these elite stocks should come back with a vengeance. Let’s first list the three things that can happen to the share price after the long stock position is entered:

  • Price goes up
  • Price goes down
  • Price stays the same

 

The price goes up

Paul’s strategy works like a charm. The price increase leads to an increase in option premium and the trade turns out more profitable than had the option been sold when the shares were purchased. This assumes that the loss in time value and/or a change in stock volatility does not negate the impact of increase in share price.

 

The price goes down 

This time the strategy does not have a happy ending. The option premium generated will be less and, in some cases, we may have to write for a lower strike price in order to generate the returns required by our initial goals (2% – 4%/month in my case). In addition to that, we have capital depletion due to a lower share value. Exit strategy execution should help mitigate losses.

 

The price stays the same

On the surface it may appear that in this situation there is no harm but that’s not the case. Despite the fact that the price remains the same, the option value will decline in value (assuming implied volatility remains the same). This is because of Theta or time value erosion of the option premium. Every calendar day that passes will result in time decay of the option premium and that decay will accelerate as we move later into the contract. Theta is not linear, but rather logarithmic (especially for near-the-money strikes) which means that it starts off slowly (yellow field) and then eventually “falls off a cliff” (brown field).  Here is a graph showing Theta’s impact on the time value of an option premium:

covered call writing and the option Greeks

Theta Graph: Time Value Erosion

 

In 2 of the 3 scenarios, we lose. These are odds I try to avoid. By selling the option at the time we purchased the security, we will generate the returns that meet our goals or we would not have selected that underlying. That being said, there are tactics we can employ to take advantage of this situation without incurring the risk suggested. We do survey the overall market and, if bullish, we can favor out-of-the-money strikes. What this accomplishes for us is that we generate the initial option profit that meets our goal and then have the opportunity for an additional income stream from share appreciation up to the strike price. For example, if a stock price had dropped from $30 to $28 and we purchased it at that lower price, we can immediately sell the $30 out-of-the-money call. Let’s assume we generate $0.90 per share or $90.00 per contract for an initial 1-month return of 3.2% Not bad so far. Now, since we are bullish on price movement (inherent in Paul’s question) we anticipate a price increase. If the price does move up to the $30.00 strike, we generate an additional $2.00 per share or $200.00 per contract. In this scenario our total 1-month profit is $290.00 on a cost basis of $2800.00 or a 10.4% 1-month return.

 

Discussion

After a market decline and shares are purchased at a lower price, it is to our advantage to immediately sell the option to generate our target goal. This way we are basing our investment decisions on information currently available, not on possible future new information. We are establishing a trade that definitely meets our target initial return goal. If we are bullish on the overall market anticipated movement, we can take advantage of that situation by favoring out-of-the-money strikes. This way we are guaranteed our initial target returns and have an opportunity to take advantage of a market recovery. Of course, we always are prepared with our exit strategies if any trade turns against us or turns out much better than expected.

*** Use the multiple tab of the Ellman Calculator to calculate initial option returns (ROO), upside potential (for out-of-the-money strikes) and downside protection (for in-the-money strikes). The breakeven price point is also calculated.

 

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:

Facebook post:

BCI is the best website to learn how to trade and manage covered calls.

Mauro from Italy

 

 

 

Upcoming events

September 14, 2019: Charlotte Chapter of The American Association for Individual Investors

“Converting Non-Dividend Stocks to Dividend-Like Securities”

Live webinar

Saturday from 10 AM – 12:PM ET

 

September 26 – 27, 2019: Philadelphia Money Show

September 26th: All Stars of Options (details to follow)

September 27th at 1:30 PM: “How to Select the Best Options in Bull and Bear Markets”

 

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Market tone data is now located on page 1 of our premium member stock 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.

20 Responses to “Timing Our Covered Call Trades: The Best Time to Sell Our Options After Buying the Stock”

  1. Jack August 31, 2019 4:03 am #

    Alan,

    Things are coming along okay. I love the DCCC Spreadsheet! It’s a great tool for managing a position.

    I have 4 current stocks with options on them.

    I think if I ever get to 10(not sure I can manage 10 stocks), if we have some bad bad news in the world what do we do so we don’t get ruined.

    I know #1 is to B-T-C following the 20%/10% rule.

    Then if everything drops big time then just sell the stocks or wait a few days or what?

    I know you have negative ETF’s to sell calls on but you have to sell your own stock at a loss in this case to buy them.

    If you are fully in the market what disaster recovery plan are you planning on using or one you can suggest?

    Am I worrying too much?

    Thanks,

    Jack

    • Alan Ellman August 31, 2019 12:16 pm #

      Jack,

      I commend you for wanting to be prepared for even the most extreme of circumstances. I would replace the word “worried” for “prepared” and we can never be too prepared.

      I we are concerned about the possibility of a catastrophic decline in the market, buying protective puts makes sense. Using lower volatility underlyings (like ETFs), selling in-the-money calls and deep out-of-the-money puts are others.

      When we are in a confirmed bear market (we are certainly not in one now), using the inverse ETFs you alluded to is a great way to go.

      Finally, if a single stock declines in value, we have our exit strategy arsenal and the stock repair strategy to lower breakeven.

      BCIers are prepared for all scenarios… the good, the bad and the ugly. Fortunately, most fall into the first category.

      Keep up the good work.

      Alan

      • Jack August 31, 2019 4:11 pm #

        Alan do you really bother with protective puts you said before not enough bang for the buck and do you really do anything with the stock repair or do you just manage your positions and cut your losses when needed.

        In the original question that I had I was referring primarily to if everything took a nose dive at once what the heck do you do.

        Jack

        • Alan Ellman September 1, 2019 8:13 am #

          Jack,

          I use our exit strategy arsenal to mitigate losses and enhance gains. Protective puts and the stock repair strategy are also great approaches to potential and realized catastrophic losses. BCI shares information and allows are members to select the best paths to take based on personal risk tolerance and trading style.

          Most major market declines are gradual and we can take appropriate action during the course of the downturn. If we see an event with the potential for a major market decline overnight (Brexit, presidential election… we already avoid earnings for individual stocks). we can temporarily move to a certain percentage of cash.

          The key to all market declines is to remove emotion from the process and adhere to a structured trading strategy that has been shown to out-perform over the long haul. This is what will distinguish good investors from elite investors.

          Alan

  2. Bill August 31, 2019 6:26 am #

    Hello Alan,

    It has been a couple of months since you sent me your CC calculator and I have been using it to assist me in my options investing. I also have the PUT Calculator. Most of my transactions have been in IRA accounts to gain experience and eliminate any tax ramifications until I was comfortable with my options investing. I am now looking to expand my investing into my taxable accounts.

    I have 2 initial objectives. The first is to write CCs against my existing portfolio of stocks to increase my income stream. Most of the stocks are dividend producing and it is a significant amount of dividends on an annual basis. I am looking to target the 8 months a year for the CCs to avoid the 4 Ex-Div. date months. Some of the stocks have no dividends and I will write the CCs 12 months a year. Some of these positions would have significant tax implications if they were called away, so I am very interested in your exit strategies, especially in avoiding the stocks being sold. If I could match the current annual dividend amount with this method, I would be extremely happy. Any increase greater than that amount would be phenomenal for me. What type of increase in income do you typically see on an annualized basis?

    My second objective (less critical) is to write cash-secured puts on Sector ETF’s or specific stocks in sectors that my portfolio is lacking (i.e. Financials, Consumer Staples and Healthcare), just as a way to balance the overall portfolio to match a conservative model. I see this method as a way to dollar cost average purchases while getting paid premiums on a monthly basis when OTM. Once exercised on any of these Puts, I would begin to include them in the monthly CC process above.

    I have looked at the books on your website and am thinking of purchasing the Family Investment Library. I wanted to make sure that the Encylopedia for CC’s will cover details to meet my first objective. The Stock Investing for Students book is one I want to read, but my main goal is to get my children started down the investing path early so it is really targeted for them.

    I appreciate any feedback about your books and my strategies.

    Thank you,

    Bill

    • Alan Ellman August 31, 2019 12:30 pm #

      Bill,

      The 2 strategies you are focusing in on are:

      1. Portfolio overwriting
      2. PCP (put-call-put) strategy

      Both are wonderful approaches to generating income streams.

      If looking to double dividend distributions, we can write 4 out-of-the-money calls per year, each generating 1/4 the dividend yield goal. We avoid months of earnings and ex-dates. Learning to roll options when indicated is critical.

      The “Complete Encyclopedia- classic” is a must. You may also want to consider “Selling cash-Secured Puts” and “Covered Call Writing Alternative Strategies”, the latter for portfolio overwriting.

      “Stock Investing for Students” is the best book for those starting out in the investing world and is now required reading in at least 4 colleges.

      What a great gift for our children and grandchildren… financial literacy… nice going.

      Alan

    • Jay September 3, 2019 6:12 pm #

      Hi Bill,

      Compliments on teaching your kids the value of money, saving and investing. My parents gave me that gift early and I owe them a lifetime of gratitude.

      I was familiar with covered calls when I came to BCI but a significant add on learning for me from Alan and Barry has been Cash Secured Puts (CSP’s). I use them all the time. I used to be a trader month to month. Now I am more a portfolio over writer. I keep some mad money on the side that I do short term options speculation with to keep some zest in my hobby 🙂

      I admire you selling options in a cash account. I know the tax issues can be daunting. I only trade options in my IRA. But I realize many friends here may not have that choice if retirement money is in company 401K’s without option capability.

      My best use of CSP’s has been to target buy levels I want and wait for them selling CSP’s for as many cycles as it takes. Since the July highs I knew we were in rare air and the next few months were seasonally problematic. So I built my cash position and began a CSP campaign at where I would like to buy back . I thought about where the June lows were – that seemed like support – and where Trump may get nervous enough about the market to start propping it up. That seemed like SPY 260 and QQQ 170 to me. So on the big wash out days when put values soar I sell a couple CSP’s at those strikes for Oct expiry. I have a pretty large cash position since I am defensive. I don’t always take in much but I am not prepared to commit money to buys at these prices and option premium is hundred fold money market monthly rates for idle cash.

      We all do it differently and sharing about it is one of the great things about this blog! – Jay

  3. Barry B August 31, 2019 9:47 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 08/30/19.

    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:

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

    Since we are in Earnings Season, be sure to read Alan’s article, “Constructing Your Covered Call Portfolio During Earnings Season”. You can access it at:

    https://www.thebluecollarinvestor.com/constructing-your-covered-call-portfolio-during-earnings-season/

    Please note that the report for 09/06/19 will be posted late on Monday, 09/09/19. I will be out of the country and will not be back home until late on 09/08/19.

    Best,

    Barry and The Blue Collar Investor Team

    [email protected]

  4. Mike September 1, 2019 12:50 pm #

    Hi Alan.

    Glad to be a new member.

    For a stock that passes screening, example CUBE, do members typically buy the stock and choose the appropriate call to sell, or instead is it typical to sell a cash secured put first in attempt to get the stock at a lower price?

    Thank you!

    Mike

    • Alan Ellman September 2, 2019 6:48 am #

      Mike,

      Both strategies (traditional covered call writing and the PCP strategy) are outstanding approaches to generate cash flow and beat the market on a consistent basis.

      I prefer the former in normal to bull market conditions and give and edge to the latter (PCP) in bear and volatile market conditions.

      Our decision is based on overall market assessment and personal risk-tolerance.

      Alan

  5. Marsha September 4, 2019 3:55 am #

    Alan,

    Since the market became more volatile with China tariff worries, I started selling puts to enter covered call trades (PCP in your book). I love the idea of the additional downside protection before buying the stock. My question is how far below the stock price should we choose the put strike? I’ve been going 1-2 strikes below but I’m looking for some kind of formula if you have one.

    Thanks,
    Marsha

    • Alan Ellman September 4, 2019 7:09 am #

      Marsha,

      As Elizabeth Warren would say, “I have a plan for that”

      It is similar to the plan we use for strike selection when using traditional covered call writing. Here’s how I do it:

      For put-selling

      1. Determine an initial time-value return goal. Let’s say it’s 2% – 4% per month.

      2. Check an option chain for out-of-the-money put strikes that generates premiums that aligns with this goal.

      3. If extremely bearish or just concerned, we go deeper out-of-the-money and accept premiums closer to the 2% return.

      4. If less bearish on the market or even bullish on the market, select strikes closer to at-the-money and to the 4% part of the targeting range.

      This is a great example why we shouldn’t use a specific Delta or implied volatility for every trade we execute (I am frequently asked about this… which Delta?…which IV?). By basing our selection on targeted goal and overall market assessment along with our personal risk-tolerance, we can craft the strategy approach for the highest possible returns at that specific point in time.

      Alan

  6. Alan Ellman September 4, 2019 5:23 pm #

    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

  7. Nick September 5, 2019 3:03 am #

    Hi Alan,

    I wondering if you can confirm they way I’ve set up my technical charts and am interpreting them. Below is chart of WEN from 7/1/19-9/9/19. Unfortunately I did not act on this chart but I’ll recognize it next time if I’m reading this correctly.

    There are 4 positive signals in this chart

    1) and 2). Jump in stock price corresponding with high volume.
    3). MACD Histogram Value line (blue) crossed the Average (yellow) line and histogram is above 0 in GREEN
    4). Slow Stochastic line cross 20% oversold line twice and Slow K line (14 day) crosses the Slow D line (3 day). This all corresponds with MACD Histogram going GREEN

    Mostly I’d like to know if you the charts you look at look the same for the WEN over the same period of 7/1/19-9/9/19.

    Thanks so much,

    Nick

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

    • Alan Ellman September 5, 2019 7:22 am #

      Nick,

      You did a masterful job interpreting this Wendy’s price chart. Congratulations.

      Let’s take this a step further. The chart show a gap-up in price on high volume. Why? The most common reason is a positive earnings report and that is precisely the event that occurred in this case (see chart below) on August 7th.

      In the BCI methodology we would not have owned the stock through the report or owned it and not written a call until the report passed. Post-report, the technical chart was all bullish and the fundamentals were most likely also bullish because the market approved of the earnings statistics. Had we entered a position post-report we would have executed a successful covered call trade based on the chart where Wendy’s moved from $18.75 to $22.25 after the gap-up.

      Keep up the good work.

      Alan

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

      • Nick September 5, 2019 2:37 pm #

        Alan,

        Thanks for the quick response. Agreed that I wouldn’t have been in a position due to earnings and wouldn’t have entered one until the next option cycle starting 08/19/19.

        Here’s the thing that confuses me every time I find a good trend. While the stock may have upside potential, there’s no return in the option at the point of analysis. I looked at both ITM-OTM for 9/20 contracts looking back at a purchase date of 8/21 (I checked 8/19 and 8/20). Any return on a writing a covered call is all in the stock appreciation, not in the premium of selling the call.

        Is that just the roll of the dice and time to analyze another stock?

        Nick

        • Alan Ellman September 5, 2019 4:45 pm #

          Nick,

          2 things:

          1. We must look at stock price and option premium at the same point in time… not sure you did that.

          2. Some stocks, WEN is one, just have low implied volatility and therefore low premiums. Even shares like these can represent decent opportunities. Based on today’s pricing, if we bought WEN at $22.79 and sold the 10/18/19 $23.00 call for $0.55, we would receive an initial 6-week time-value return of 2.4% with an additional upside of 0.9%. This return (ROO + Upside) annualized to 29%. See screenshot below.

          If a great performer does not generate the returns that meet our goals, we move on. For some investors, WEN is a good option-selling candidate while others may seek higher returns.

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

          Alan

          • Nick September 6, 2019 4:02 am
            #

            Thanks Alan. Yeah I had look at both ask a “think back trade” on 8/21.

            I confirmed that the $23 strike for 10/19 would generate the returns you indicated. Although that strike doesn’t have enough Open Interest to trade at this point.

            Thanks for the dialog. I really do appreciate the hand holding as I get started.

            Nick

          • Alan Ellman September 6, 2019 9:53 am
            #

            Nick,

            As of this morning, the open interest and bid-ask spread are reasonable and should not eliminate this equity for consideration. See screenshot below.

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

            Alan

  8. Alan Ellman September 5, 2019 10:42 am #

    Options Calendar 2020:

    Thanks to Francesco from Italy for sharing the Options Expiration calendar for 2020.

    Premium members: I have added tis image to the “resources/downloads section of our member site.

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

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