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Using Implied Volatility to Determine Safe Strikes for Portfolio Overwriting: A Real-Life Example with PayPal Holdings, Inc. (Nasdaq: PYPL)

is a covered call writing-like strategy. We use it with our long-term buy-and-hold portfolios in non-sheltered accounts with the objectives to generate additional cash-flow while still retaining the shares. Share retention is a required objective to avoid potential negative tax issues. In my books and online videos, I suggest a 6% – 8% annualized return target that can be adjusted to meet our strategy goals. In this article, I will provide another approach to selecting the out-of-the-money covered call strikes to meet both goals using implied volatility and projected trading range over the course of the contracts.

 

Strategy protocol

  • Locate an elite-performing stock or ETF
  • Access the mean implied volatility for that security (cboe.com, ivolatility.com, all brokerages)
  • Convert the annualized IV stat to a contract specific IV (BCI Expected Trading Range Calculator) to generate a projected trading range
  •  Use the upper end of that range to select the most appropriate strike
  • Selecting a strike at the upper end of the IV-based trading range will result in an 84% probability of success trade
  • Access an option-chain to view option premiums
  • Use the BCI Trade Management Calculator to confirm the returns meet our stated goals

 

Implied Volatility: 33.07

 

PYPL: Implied Volatility as per iVolatility.com

 

trading range calculations: BCI Trading Range Calculator

PYPL: Expected Trading Range Based on Implied Volatility

 

The spreadsheet shows a projected trading range between $269.81 and $326.33 with the current price at $298.07. For portfolio overwriting, we will check the strikes near $326.33.

***The formula inherent in the spreadsheet is located at the bottom of the screenshot in red.

 

Option-chain data for 1-month August 20, 2021, expirations

 

Option-Chain on 7-21-2021

 

We will use the published prices for the $325.00 and $330.00 strikes.

 

calculations using the BCI Trade Management Calculator

 

PYPL: Calculations for Upper End Trading Range Strikes

 

  • The $325.00 strike generates an initial annualized return of 10.82%, with an additional 9.03% of upside potential
  • The $330.00 strike generates an initial annualized return of 8.49%, with an additional 10.71% of upside potential
  • If our target annualized return is 8% – 10%, both strikes will meet our goals. The deeper out-of-the-money $330.00 strike is safer and still meets our time-value stated goal

 

Discussion

Implied volatility can be used to establish a trading range specific for every option contract period. When portfolio overwriting, we establish an upper end of the trading range and check to make sure that the targeted strikes will meet our stated strategy income goals.

 

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 last name unless given permission:

Hi Alan,

Based on my few weeks of doing covered calls and with the knowledge I have gained from your books and videos, it is working out great, even in this terrible market.

Your weekly stock and ETF lists are also great. I’m sure I’ll have some pointed questions for you or the larger BCI community, but so far, so good!

Thank you, Simon

 

Upcoming

1.Money Show Canada Virtual Event

Analyzing a 1-Month Covered Call Writing Portfolio from Start-To-Finish

A real-life example with a $100k ETF portfolio 

May 24, 2022

10:40 AM ET – 11:10 AM ET

Covered call writing is a low-risk option-selling 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 S&P 500 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

Register for free here

 

2. Mad Hedge Investor Summit

June 15th, 2022

12 PM ET – 1 PM ET

Topic & registration link to follow

 

3.American Association of Individual Investors: Greensboro North Carolina Chapter

Saturday June 18, 2022

10 AM – 12 PM ET

The PCP (put-call-put or wheel) Strategy

Using both covered call writing and selling cash-secured in a multi-tiered low-risk option-selling strategy where we either generate cash-flow or buy a stock at a discount.

Zoom webinar for Chapter members

 

4. Money Show Orlando live event

October 30th – November 1st, 2022

OMNI ORLANDO RESORT AT CHAMPIONSGATE

Visit Alan, Barry and members of the BCI team at Booth # 415

Details to follow.

 

Alan speaking at a Money Show event

***********************************************************************************************************************

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

****************************************************************************************************************

 

 

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.

19 Responses to “Using Implied Volatility to Determine Safe Strikes for Portfolio Overwriting: A Real-Life Example with PayPal Holdings, Inc. (Nasdaq: PYPL)”

  1. Barry B May 21, 2022 11:29 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 05/20/22.

    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

    Best,

    Barry and The Blue Collar Investor Team
    [email protected]

  2. Michelle May 22, 2022 1:22 am #

    Alan,

    I’m not very good at math. Can you explain how I can use this formula with a standard hand held calculator?

    Thanks a lot.

    Michelle

    • Alan Ellman May 22, 2022 9:08 am #

      Michelle,

      Glad to help.

      Step #1: Locate the implied volatility from any of the resources mentioned in this article. This represents an annualized statistic that must be converted to a contract-specific implied volatility.

      Step #2: Calculate the conversion factor: Divide the number of days to expiration (30, in this case) by 365. Once we have this figure on the calculator, click the square root icon. This will give us the conversion factor.

      Step #3: Multiply the price of the stock x standard IV (33.07%) x conversion factor = projected $ price movement of stock during the specific contract ($28.26), up or down. This represents a projected trading range from $269.81 to $326.33 during this specific contract.

      If you are a premium member, simply use the Expected Price Movement Calculator in the “resources/downloads” section of the member site.

      Alan

  3. Danielle May 22, 2022 10:33 am #

    Alan,

    In this weekend’s stock report you say that you will be using an equal number of itm and otm strikes. How do you decide which ones are itm or otm?

    Thanks,
    Danielle

    • Alan Ellman May 23, 2022 6:54 am #

      Danielle,

      I favor OTM call strikes on stocks with strong technical charts and ETFs with the best price performance over the past month. When selling multiple contracts with the same underlying security, I establish a mix of OTM and ITM.

      Let’s say I am selling 6 contracts of a stock with a strong bullish technical chart. I may use 4 OTM and 2 ITM. If the stock has a mixed technical chart, the ratio would be reversed.

      When all positions are established, the total portfolio mix would be approximately 50/50.

      Alan

  4. Daniele May 23, 2022 3:33 pm #

    Hi Alan,

    I bought shares for $ 10.

    The stock now trades at $ 4.

    I would like to use the covered call sale to lower the average carrying price and generate cash flow, without being called away to avoid recording a loss.

    What strategies do you recommend to use to avoid being called away?

    Where can I specifically learn more?

    Thanks in advance.

    Best Regards.
    Daniele.

    • Alan Ellman May 24, 2022 6:46 am #

      Daniele,

      First, make sure the stock has options associated with it. Not all stocks and exchange-traded funds have options. Let’s assume it does:

      1. Check an option-chain for the premiums you will receive when you sell covered calls.

      2. Locate the out-of-the-money strike (higher than current market value) that will return a premium that aligns with your return goal range.

      3. Be prepared with exit strategy techniques to mitigate losses and enhance gains.

      4. Be prepared to roll options if the stock price moves higher than the option strike price by expiration Friday.

      5. The education comes before strategy implementation.

      Here are our best resources to start the learning process:

      https://www.thebluecollarinvestor.com/alan-ellmans-complete-encyclopedia-for-covered-call-writing-scover/

      https://thebluecollarinvestor.com/minimembership/covered-call-writing-package-4-dvd-series-workbook/

      One final thought. Let’s say we have 100 shares at $10.00 per-share to start and share price declines to $4.00. We started with $1000.00 worth of stock and now have $400.00 worth of stock. We ask ourselves, “where is that $400.00 best placed?” In that same stock or a better-performing one? It’s not the stock but the cash that is important to us and we are not married to 1 particular security. I’m not saying that we must sell all under-performers, but I am saying that it is a consideration.

      Alan

      • Daniele May 24, 2022 12:38 pm #

        Hi Alan,

        I have read 3 of your books, now I have bought complete encyclopedia per covered call-classic edition to become a better investor.

        In your opinion, in my case is it possible to use Portfolio Overwriting strategy to generate cash flow and keep the underlying stock avoiding the assignment?

        Thanks.

        Best Regards.

        Daniele

        • Alan Ellman May 25, 2022 5:57 am #

          Daniele,

          We can use portfolio overwriting when our objectives are to generate cash flow and retain the underlying shares. We use deep out-of-the-money call strikes and avoid ex-dividend dates (when applicable) and earnings reports.

          We must also be prepared to roll options when the strike is expiring in-the-money.

          Early exercise is extremely rare (especially if we avoid ex-dates) but possible, so there is a small risk of losing our shares.

          Alan

  5. Alan Ellman May 24, 2022 5:00 pm #

    Premium members:

    This week’s 4-page report of top-performing ETFs and analysis of the top-performing Select Sector SPDRs has been uploaded to your premium site. One and three-month analysis are included in the report. Weekly performance has also been incorporated into the report although not part of the screening process. Weekly option availability and implied volatility stats are also incorporated.

    The mid-week market tone is located on page 1 of the report.

    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

    NOT A PREMIUM MEMBER? Check out this link:

    https://www.thebluecollarinvestor.com/membership.shtml

    Alan and the BCI team

  6. Roni May 25, 2022 10:59 am #

    Dear Alan,

    After significant losses in the recent options cycle, I have decided to unwind the remaining trades and stay 100% in cash until the bottom of the equities sell-off is reached, and a stable recovery is confirmed.

    I hope to be back soon.

    Roni

    • Alan Ellman May 26, 2022 7:13 am #

      Roni,

      I have received emails from some other BCI members sharing that they have cut back on the amount of cash being invested. Each of us should only invest in market conditions that align with our personal risk tolerance and comfort levels.

      If inflation spiked in March, as Janet Yellen stated, we should start to see a decline in the VIX (CBOE volatility index or investor fear gauge), which will result in a calmer trading environment.

      Alan

      • Roni May 26, 2022 10:29 am #

        Thank you, Alan,

        I am watching each day, and it looks like the bottom was reached right after I decided to liquidate, making me regret my decision today. But if the market continues to improve, I will be happy to resume my monthly CC trading.

        Roni

  7. Hoyt T May 26, 2022 9:09 am #

    Hey Roni,

    I feel your pain my friend.

    As both a retired person and both an investor and an options trader, bear markets, and we can argue whether or not the last five months have been one, are especially cruel.

    In times like these, I tell my grandchildren to load up their accounts with SPY, QQQ, XLK, and IWM. Myself, I worry if this time is going to be the one that takes years to come back. We have had those several decades ago.

    My problem is simple. As an investor, since stocks rarely expire, and major market indices never do, I hold on and try to buy more at a discount. As an options trader, since options do expire, I am taking a much larger hit with little hope of recouping my losses.

    As you know I do/did a lot of credit put spreads on SPY. I would sell at around the -0.26 Delta range, that used to be outside the expected range, and buy $5 below that laddering 3, 6, 9, and 12 months out. It worked fine until it didn’t anymore. As a matter of fact, it has now worked horribly!

    As an options trader, as Alan noted, one can use the VIX to decide when to get back into the market. In this five month cycle the VIX touched 39 once and closed at a cycle high of 37 on 2/24. I personally prefer to trade with the VIX under 20. Oh, for those days of yesteryear, actually only last year!

    As an investor it is much more difficult to know when to re-enter. A lot of folks wait too long to re-enter and come back in at the new top.

    Each of us have different risk tolerance levels. In my family I am the only high risk tolerant one, save one granddaughter.

    You are correct to make your decisions based on your personal risk tolerance. That has always been the first step in the BCI methodology.

    Best wishes, my friend.

    Hoyt T

    • Roni May 26, 2022 10:53 am #

      Hoyt,

      Thank you for your kind words and wise comments.

      The market improved this week, right after my radical decision, and I hope it continues that way.
      I will keep an eye on the VIX, and if it goes down to the level you mentioned, I will return to my regular monthly CC trading.

      On the other hand, there are several headwinds still blowing:
      Inflation, interest rate hikes, supply chain disturbance, and the Ukraine war. Therefore, I believe the market will take some time to stabilize.

      Best wishes to you too.

      Roni

  8. Harley May 27, 2022 1:01 am #

    Alan, in your presentation on Tuesday, which I enjoyed, one criteria was to locate best performing spyders over the past month. Does that mean one should only consider those with positive percentage during this period, or are those with less negative performance also considered?

    Looking at the past monthly performance this morning, only 3 of the 11 sectors are positive. I haven’t computed whether any of them meet the ROO criteria.

    Thanks,

    Harley

    • Alan Ellman May 27, 2022 7:06 am #

      Harley,

      For a $100k portfolio, I prefer the diversification of at least 4 securities. If only 3 are in positive territory over the past 1-month, I would select the next best performer.

      You will almost always find that these securities will, have initial time-value returns between 1% and 2% per month for near-the-money strikes.

      Glad you enjoyed my presentation.

      Alan

  9. Jean Philippe June 23, 2022 9:01 am #

    Dear Alan

    Thank you very much for this extremelly valuable information.
    I have two questions
    -On Yahoo finance, we can see the Implied volatilty, is this the one you use for the calculation.
    – I don’t understand clearly why we use the Implied volatility correspondting to the strike at the money and not the implied volatility for the strike corresponding to the level you want to sell the call.
    Thank you
    Sincerely

  10. Alan Ellman June 24, 2022 6:05 am #

    Jean,

    When we use IV to determine the expected trading range of a security for a specific contract period, we focus in on the movement of that stock from its current price. Not all strikes with the same contract expirations have the same volatility stats. This is known as “volatility skew” I have written about this phenomenon in the past:

    https://www.thebluecollarinvestor.com/volatility-skews-defined-explained-and-updated/

    Therefore, we focus in on the near-the-money strike or an IV mean (see below).

    Yahoo Finance is, generally a reliable site. I have not analyzed the accuracy of their IV stats.

    The sites I have used are:

    http://www.cboe.com (near-the-money strikes)

    http://www.ivolatility.com (IV index mean)

    See the image below taken yesterday from ivolaitlity.com.

    Either of the sites above will be accurate for determining expected price movement during a specific contract.

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

    Alan

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