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Using the Nasdaq-100 Volatility Index (VOLQ) in Covered Call Writing Decisions: A Real-Life Example with Invesco QQQ Trust (Nasdaq: QQQ)

One of the most popular exchange-traded funds (ETFs) used as underlyings for covered call writing is Invesco QQQ Trust (Nasdaq: QQQ) which consists of 100 of the largest domestic and international non-financial companies listed on the Nasdaq exchange. It is the ETF I have used the most over the past 2 decades of option-selling. This article will highlight a methodology of incorporating The Nasdaq-100 Volatility Index (VOLQ) into a low-risk strategy targeting a 10% – 15% annualized return.

 

What is VOLQ?

This is a 30-day measure of the implied volatility of the Nasdaq 100 Index (NDX) as expressed by at-the-money (ATM) NDX options. It is based on 1 standard deviation (68% accuracy). This information can provide investors with an expected trading range of NDX over the next 30-days.

 

What is covered call writing?

This is a low-risk option-selling strategy where a security is purchased in 100 share increments and then call options are sold leveraging those securities. Option sellers are undertaking the obligation to sell those shares at the strike price while option buyers hold the rights to exercise the options at any time during the contract (American-style options). In return for undertaking the obligation, covered call writers are paid a premium.

 

Proposed QQQ/VOLQ strategy

Determine the expected trading range of QQQ over the next 30-days based on VOLQ. Use the low end of the range to determine the target premium for selling an in-the-money (ITM) call option which will bring our breakeven to that low-end price point. Any time-value component of that premium will become realized profit if share price does not dip below that deep ITM strike price.

 

Real-life covered call trade example with QQQ on 10/22/2020 (the stats)

  • QQQ is trading at $284.32
  • VOLQ is listed at 32.16
  • Expected 30-day % price change based on VOLQ is 9.29% (32.16/3.46), where 3.46 is the square root of 12 (# 30-day cycles in a year)
  • 9.29% of $284.32 is $26.69, leaving an expected price range for QQQ between $257.63 and $311.01
  • Our target premium for selling an ITM call option for QQQ is $26.69 which will bring us down to the low point of the expected range
  • We must make sure there is a time-value component that will remain to meet our 10% – 15% annualized return goal range
  • The intrinsic-value component of the premium will be used to “buy down” the cost basis from $284.32 to the strike price

 

QQQ option-chain (11/20/2020 expiration)

QQQ Option-Chain on 10/22/2020

  • The $261.00 strike shows a bid price of $26.47, aligning with our target price of $26.69.

 

Initial covered call writing calculations using The Ellman Calculator

 

QQQ 1-Month Initial Calculations

 

  • The breakeven price point is $257.85, aligning with our target of $257.63
  • The time-value return on the option (ROO) is 1.2%, 14.4% annualized falling within our 10% – 15% targeted annualized return goal range ($3.15/$261.00)
  • Since an ITM strike was sold, there is no upside potential relating to share appreciation
  • There is an 8.2% downside protection of the time-value profit (different from breakeven). This means that an investor is guaranteed a 1.2% 1-month return as long as share value does not decline by more than 8.2% by contract expiration

 

Discussion

VOLQ can be an extremely useful tool when covered call writing with QQQ to establish a target strike price when seeking to generate significant annualized returns incorporating a low-risk, high probability approach. This strategy is especially attractive in low interest rate environments like we are currently experiencing.

 

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:

Hi Alan,

I have traded options before but not sold covered calls or puts so I has a basic idea of what goes on but not an in-depth knowledge required to maximize profits and minimize losses. The Blue Collar Investor has this knowledge and knows how to impart it in a way that can be easily grasped by anyone. I watched your videos and bought your book. I am now in a much better position to trade consistently using mathematics rather than intuition.

Thank you, Alan,

Perry

 

Upcoming events

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May: A link to the interview will posted on this site and in social media when provided to BCI

Interview with Casey Stubbs

The focus will be on “my story” and analysis of my go-to strategies

 

2. Mad Hedge Traders and Investors Summit

June 8th – June 10th

Details to follow.

 

3. Money Show Virtual Expo

July 13th – July 15th

2-hour Money Masters Course (paid event to The Money Show)

4 Practical Applications to Selling Cash-Secured Puts

Details to come

 

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.

26 Responses to “Using the Nasdaq-100 Volatility Index (VOLQ) in Covered Call Writing Decisions: A Real-Life Example with Invesco QQQ Trust (Nasdaq: QQQ)”

  1. Safi April 24, 2021 2:55 am #

    Hi Dr. Ellman,

    On Monday, I plan to sell a weekly CSP on NIO.

    With NIO on an upswing and an expected positive earnings expected middle of next week, I think NIO will go up.

    My question is with NIO expected to go up, should I sell a CSP for a strike price of 43 instead of the barely OTM 41 strike price? The reason for that is a juicy premium of 3.05 on the 43 strike price compared to the 1.88 on the 41 strike price. See option-chain below.

    What are your thoughts?

    So even if NIO goes to lets say 43 and up, I get to own it and pocket the 3.05 premium?

    The other question is what happens on expiration if NIO does not hit 43, I’m assuming I don’t get the shares, but just get to keep the premium, Correct?

    My first time with CSP next week, I’m hoping.

    Thanks for all your help

    Safi

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

    • Alan Ellman April 24, 2021 5:25 am #

      Safi,

      The proposed trade has 2 legitimate goals: Generate cash flow (that’s what BCI is all about) and to purchase NIO at a discount. Selling cash-secured puts is the perfect strategy to accomplish these goals but never when it is at the expense of high-risk because capital preservation is critical to all BCI option-selling strategies.

      Let’s calculate the initial time-value return on the slightly out-of-the-money $41.00 put for this weekly trade: The annualized return is 250%. This tells us that the implied volatility (IV) of NIO, at this point in time, is extremely high, making this trade highly risky.

      The main reason for the high IV is the upcoming (4/29) earnings report. One disappointing aspect to the report can wipe at all our premium profit and then some. We never sell an option when there is an upcoming earnings report prior to contract expiration. It is a risky event, we know the date and we avoid it.

      This means that the put can be sold after 4/29. Since the report will have passed, the IV will decline substantially and so will the premium but it will still result in significant annualized returns but not 250%. The option-chain data will look different so there is no need to make decisions based on the current chain.

      If we have a dual goal of generating time-value premium and buying a stock at a discount sooner rather than later, selling an in-the-money cash-secured put is a reasonable approach.

      Alan

  2. Marja April 24, 2021 6:01 pm #

    Hi Alan,

    I was just reading an article you wrote a few years ago on 1-time special dividends and I wondered if you might know the answer to my options question – so here it is: What happens to a call option when the strike price is below the amount of the special dividend?

    In this case, I own 500 $8 call options for Microvision and I think there is a moderately good change that a dividend greater than $10 will be issued.

    Do you think in that instance that I am likely to receive the shares plus $2 each (or the strike price will become negative and not automatically execute) or something else will happen?

    Thank you for taking the time to read this, any input you have is great appreciated,

    Marja

    • Alan Ellman April 25, 2021 7:34 am #

      Marja,

      For purposes of this response, let’s assume the special 1-time cash dividend is $10.00.

      In order to receive that dividend, owners of call options must exercise those options and own the actual shares prior to the ex-dividend date. Options owners do not capture dividends.

      On the ex-date, owners of Microvision are guaranteed to receive the cash dividend on the pay date, some time after the ex-date.

      It is important to also realize that share price and option strikes will decline by $10.00 on the ex-date to account for this dividend distribution. The Options Clearing Corporation (OCC) will see to it that all buyers and sellers of options “are made whole”

      Alan

  3. Barry B April 24, 2021 9:59 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 04/23/21.

    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

    On the front page of the Weekly Stock Report, we now display the Top Performing ETFs, the Top SPDR Sector Funds, and the 4 single Inverse Index Funds. They are sorted using the 1-month performances from the Wednesday night ETF report and the prices from the weekend close

    Since we are now 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/.

    Best,

    Barry and The Blue Collar Investor Team

    [email protected]

  4. Ed April 25, 2021 2:55 am #

    Hello Alan:

    In your 4/21 ETF report you mentioned that you purchased the ‘elite performing stocks and ETFs’ from the member reports. By elite performing stocks do you mean only those stocks whose tickers in the Running List Symbol column appear in bold black font? Or is the fact that the stock is listed at all the indicator that it is an ‘elite performing’ stock. I realize that the list is a list derived from massive culling of candidate tickers from IBD and other sources and that any listed ticker is certainly already superior than most of the overall stock universe.

    I realize that BCI is a stock screening system and not a stock recommendation service.

    If my question is ‘out of line’ please don’t hesitate to let me know.

    Best regards,

    Ed

    • Alan Ellman April 25, 2021 7:39 am #

      Ed,

      Glad to respond.

      All “eligible” stocks and ETFs in our reports are “elite-performers”

      Stocks from fundamental, technical and common-sense perspectives and ETFs from price-performance in comparison to the S&P 500 in 1- and 3-month time-frames.

      When these reports are constructed, I print them out and place them on my computer desk and all my selections are made from these lists.

      Alan

  5. Todd April 25, 2021 1:00 pm #

    Alan,

    I noticed that BLDR’s ER date was changed from the last report to May 6 now. Given I have established a position in BLDR, what is the recommended action? The stock still appears stable so may be willing to hold through earnings next week.

    Thanks.

    Sincerely,

    Todd

    • Alan Ellman April 26, 2021 6:49 am #

      Todd,

      When there is an ER change and we still have confidence in the stock, we close the short call prior to the ER date let the report pass and then write the new call after post-report volatility (if any) subsides.

      Alan

      • Todd April 26, 2021 12:44 pm #

        Thanks for the input Alan.

        Do you buy back the option to avoid missing out on upside if we are still confident in the stock? And if the option price is higher now than what we sold it for, do we need to take that into account? Or is that covered by the underlying stock price appreciation. I don’t recall reading about this in either of your books. Want to understand the fundamentals of the strategy.

        And just in case it ever happens the other way around, if there is an earnings report that pops up on a stock one is not still as confident in, do you close out both the option and underlying position regardless of where the stock is? Or are there certain conditions to be met?

        Thanks.

        Sincerely,

        Todd

        • Alan Ellman April 27, 2021 5:49 am #

          Todd,

          1. Yes, I buy back the short call to benefit from a favorable report and hold the stock if I still have confidence in that security.

          2. If the option price is higher, it is most likely a result of share appreciation since Theta (time-value erosion) is decreasing the time-value so Delta (share appreciation) is probably the reason. Implied volatility could be a factor if the ER date was changed to now occur in the current contract sold.

          3. If there is an upcoming ER on a stock that we lack confidence in, we either don’t enter the trade initially or close both legs to mitigate potential losses. There are plenty of choices available (most of the time). We go with a stronger selection.

          4. An exception to #3 would be if we are “portfolio overwriting” on long-term buy-and-hold stocks that we are committed to holding, perhaps for tax reasons.

          Alan

          • Todd April 27, 2021 12:16 pm
            #

            Thanks Alan! Very helpful.

          • Roni April 29, 2021 1:42 pm
            #

            Alan and Todd,

            When BLDR surprised us with an early ER last week, I was in the same situation as Todd.
            I decided to buy back the 50.00 ITM short calls immediately, at a 2% gain, and hold the shares a few days, hoping they would rise.
            When BLDR did rise on 04/27, I sold the shares @ 50.32.
            My total gain was 2.17% in 8 days. Very lucky, I placed the resulting cash on another 05/21 CC trade.
            Actually, I was not going to hold the shares through earnings because the odds are 50/50.

            We also had an early ER schedule for MTZ, which was one of my 05/21 CC trades, which I liquidated immediately with a 1% gain in 3 days. Very lucky too, I replaced it with an ER-free 05/21 CC trade.

            Now let’s hope that we all have a great 05/21 cycle.

            Roni

  6. Mark April 26, 2021 12:42 pm #

    Alan,

    I have a process question for you. I have an AXP position. It had earnings on the 23rd so I did not sell more shorts on April expiration but I left the long open. I bought back the short for .09 on the 15th and recorded the trade for April with the stock at $146.10 and a profit of 14% which was great. I then waited for earnings and the stock dropped which made me question my decision to leave the long on but the stock rebounded today and I sold shorts again for May with the stock at $149.26. I used today’s price in my calculations for the May expiration period.

    My question is how to treat the $3.16 gain in the stock price? It’s not really part of the April cycle and not really part of the May cycle. I want to be consistent in how I record it as I have the opposite problem with INTC which gapped way down and I haven’t decided what to do with it yet.

    Thanks,
    Mark

    • Alan Ellman April 27, 2021 6:01 am #

      Mark,

      We must be careful not to merge initial trade calculations with overall portfolio results.

      You are 100% correct to use $149.26 as the stock cost-basis because that is the value when the trade is initiated. It will give us an accurate time-value return, upside potential and/or downside protection along with breakeven.

      What if the stock was purchased years ago at $50.00? Value at the time of the trade will guide us to the best option-selling decisions.

      Now, there is an unrealized stock gain of $3.16 per-share but the final chapter of that position is yet to be written when calculating overall portfolio performance.

      Alan

  7. Alan Ellman April 26, 2021 10:06 pm #

    Premium Members: Just added to the member site (left side, scroll down):

    Blue Hour Webinar 16: Structuring Covered Call Trades to Meet Various Trading Goals

    I hope you enjoy and benefit from this new webinar.

    Alan

  8. young April 28, 2021 11:39 am #

    Hi,Alan:

    The idea for QQQ/VOLQ is good. will it be applied for SPY or DIA?
    Thanks,
    Young

  9. Amit April 28, 2021 12:50 pm #

    Hi Alan,

    Hopefully all well with you.

    Had another question, I keep deploying this strategy and was wondering if i should wait for a down day in order to sell the put. I notice that on a down day, I get a lot more premium and also can get a lower price, meaning less of a chance to get assigned. If Monday is a good day for the stock and it is going up, I get much less premium and higher price.

    thanks,
    Amit.

    • Alan Ellman April 29, 2021 6:08 am #

      Amit,

      I enter weekly contracts on Monday. Monthly contracts can be entered on the Monday or Tuesday after expiration Friday for 4-week contracts and up to Wednesday, maybe Thursday for 5-week contracts. The market is impossible to time and we have Theta eroding our time-value premium every calendar day.

      Alan

      • Amit April 29, 2021 8:09 am #

        Hi Alan,

        Thank you, I have done only weekly so far.
        .
        Does this strategy work on monthly also? Seems monthly would have so much more swings.

        Thank you,
        Amit.

        • Alan Ellman April 30, 2021 6:08 am #

          Amit,

          Absolutely. Selling calls and puts can be utilized with both weekly and monthly options. There are pros and cons to both.

          For example, Weeklys may result in higher annualized returns and allow us to easily avoid earnings report dates. Monthlys require less management and have many more stocks in the option pool than those that also have Weeklys.

          Both work.

          Alan

  10. Alan Ellman April 28, 2021 5:30 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.
    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

  11. Terry May 4, 2021 9:00 am #

    Sell in May?

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