For covered call writers and sellers of cash-secured puts, rising volatility has two faces. It is our friend in that our premiums will be higher as they are directly related to the implied volatility of the underlying securities. It is our enemy as we will be subjected to greater downside risk. So, which is it… our friend or our enemy? This article will make the case for the latter.
The crash of 2008
Many of us recall the market crash in the latter half of 2008 where the market lost nearly 40% of its value. A significant percentage of retail investors took a major financial hit and (unfortunately) never returned to the market. Starting in March 2009, the recovery began at an historic rate and continued through the end of 2019 as I pen this article.
The CBOE Volatility Index (VIX) from 2008 – 2019
The chart depicts a huge spike in the VIX in the latter part of 2008 (up to 80) and then a decline (to 12) by the end of 2019.
Comparison chart of the VIX and the S&P 500 from 2008 through 2019
The yellow field shows a substantial spike in the VIX corresponding to the market crash of 2008. The pink field shows an historic decline in the VIX analogous the dramatic market acceleration over the next decade.
Covered call writing and put-selling are conservative strategies for conservative investors. We look to generate small but consistent returns (singles and doubles but never grand slam home runs). When volatility runs high, we favor defensive positions (in-the-money calls and deeper out-of-the-money puts). On the other hand, when volatility declines, we take more aggressive positions using out-of-the-money calls and slightly out-of-the-money puts. That said, there are other factors to consider like chart technicals and personal risk-tolerance so these conclusions should be used as guidelines.
A macro view of market volatility from the crash of 2008 and the subsequent decade makes a case that high volatility is a negative for conservative option-selling strategies and should dictate a more defensive approach. That’s where we are now with the coronavirus crisis. A declining or consolidating VIX at historically low levels will guide us to take more aggressive positions.
Coronavirus-related comparison chart
The chart confirms the huge price decline of the market along with the exponential acceleration of the VIX. This market is an aberration where we normally don’t see moves to this extent. Most retail investors should consider moving to cash when volatility is so high and chart technicals are extremely bearish. The use of Inverse ETFs can be used to mitigate losses or even create positive cash flow.
Coronavirus trading video
BCI Market Assessment
I am in 50% cash with a dominant presence of Inverse ETFs. All inverse ETF options for the March contracts expired in-the-money due the 15% decline in the market this past week. My tentative plan (I want to review option-pricing on Monday) for the April contracts is to remain in 50% cash and take equal positions with the better-performing SelectSector SPDRs and SH, the inverse ETF for the S&P 500. This is similar to fund managers moving to Delta-neutral portfolios to minimize market risk. Depending on option prices on Monday, I will favor in-the-money strikes on all securities. The rationale is that by taking both bullish and bearish positions and lowering my cost-basis to the greatest extent with ITM strikes, I will benefit from market movement in both directions. Of course, our upside is capped as with our covered call positions, so our exit strategy arsenal must be ready for action (20%/10% guidelines immediately put in place). I have never used this approach before so I don’t recommend you do so but I’ll be happy to report back to you on final contract results. I remain long-term bullish.
Free webinar replay
With most of us confined to our homes, I thought I would share a recent webinar I hosted for a stock investment club in NY:
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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:
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Wednesday April 8, 2020 Options Industry Council (OIC) Free Webinar
Covered Call Writing to Generate Monthly Cash-Flow:
Option Basics and Practical Application
Market tone data is now located on page 1 of our premium member stock reports and page 8 of our mid-week ETF reports.
I’ve just bought LEAPs on Mastercard (January 2022 expiration) as the company perfectly fits into my long-term trading strategy and I see selling pressure drying up (at least the movements are getting smaller because of Fed actions).
I immediately sold covered calls against the position, turning it into a PMCC.
I paid 4600 dollars per LEAP and captured 1000 dollars in cash for a one-week option to immediately pay down my cost basis. It’s an unbelievable return in such a short period of time.
So whilst the market is very volatile right now, the premiums are so juicy and by using the PMCC strategy I feel we can immediately reduce a lot of risk. Is this a good approach to looking at covered call writing versus buying ordinary stock?
Take care, stay healthy and I’m continuing to closely follow the BCI community!
Thanks for all you do.
An increase in initial return on capital (investment) is definitely one of the advantages of the PMCC. That said, every strategy has its plusses and minuses (see screenshot below taken from our book, “Covered Call Writing Alternative Strategies”) so all factors should be considered when making our investment decisions. There are a multiplicity of “moving parts” that must be mastered before implementing this strategy.
In my humble opinion, I believe that current market conditions are not appropriate for most retail investors. The high market volatility does result in higher option premiums but also subjects us to higher risk to the downside.
Once the coronavirus crisis is under control and a confirmed market bottom is established, there will be amazing investment opportunities as the bull market returns.
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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 03/20/20.
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:
Barry and The Blue Collar Investor Team
Thanks so much for your wisdom and insights in your books.
I will be getting started as a premium member after completing a little more study and preparation, and when the market volatility settles down a little.
I will be starting out with only about $5,000 to invest. Please advise as to the best way to proceed, and where to find a quick start sheet to follow.
So many retail investors start out exactly where you are today.
The first step is to boost portfolio cash available such that proper diversification can be achieved for low-risk option-selling.
Here is a link for our best resource to achieve this in a mostly automated format:
While your portfolio wealth is growing, mastering the 3-required kills for option-selling should continue using our books, DVDs reading our blog articles/commentary and all the free resources on our website.
Our premium membership is not necessary at this time.
Coronavirus: new video:
I created this video today relating to the challenging market conditions relating to the coronavirus crisis. In the presentation, I share actual trades and screenshots taken from one of my ETF portfolios:
Thank you, Alan, for your “Coronavirus trading video”. Just listened to it. Very instructive. Great example of managing your portfolio in a volatile market. Exit strategies in action.
Hi Alan-how did you choose your share price to sell your covered call positions at? Are you setting automatic sell orders when the share price drops?
Strike price selection is based on:
1. “Moneyness” of option. I use OTM calls in normal to bull market conditions and ITM calls in bear and volatile markets.
2. Initial time-value return goal range. Let’s say my goal is 2% – 4% for initial time-value premium. I view the option-chain for ITM or OTM strikes (depending on my “moneyness” decision) that meets this goal.
Once the position is entered, I immediately set a buy-to-close (BTC) limit order based on the 20%/10% guidelines to buy back the short call if price declines to those thresholds.
Position management is detailed in my books and DVDs in the “Exit Strategy” sections.
Hi Alan-thank you for the reply. I have several books of yours and the online course. Your material is clear and I can understand it clearly! Thanks you for putting these resources together.
I understand the parameters to buy back the short call but I am not clear on how to handle my position (100 shares) in the stock. If the price of the stock drops severely like in this crash, how do you calculate an exit price of the stock if you I choose to do this? And do you setup an automatic sell order to do this?
In your video you mentioned you lost about 4 to 6k by selling your stock and moved to 50% cash. Did you use a certain parameter to sell your stock (100 shares) at a certain price?
Also what is your take on bear call spreads in this market? Do you plan on putting together a book on these trades?
In general, a 7% – 8% share price depreciation is a reasonable range to consider selling an underlying.
The current market situation is an aberration. I decided last month to sell most of my positions and leave some in cash, a few of the better-performing stocks and ETFs and the rest in inverse ETFs.
For most retail investors, this is a dangerous market to trade in.
Thank you for the “BCI Market Assessment” section in the above article. It’s at least coincidence – but likely me following the same logic trail you did after reading your books and being a long time blog member – I ended up doing the same thing through my own conclusions.
Once the virus case count started mounting here I sold things to increase cash. I used some of it to start a position in SH. I wish I had done both sooner. But my timing is far from perfect! On subsequent up days I built more cash and bought more SH.
I have covered my remaining holdings but I am letting SH run since I bought it as a speed bump/circuit breaker and don’t want to cap it.
This is very much a “weather the storm” strategy I have never used either. In my options trading, should members also do that, I am finding bearish spread trades keep me in the game. I enter those on the bounce up days.
Like you, I also believe the recovery from this will be strong. It will take longer since the market never goes up as fast as it goes down. But at some point not too far off the trend will change.
Thank you for your insights and best to all. – Jay
How are you? I have a question which is the following:
What could happen if I buy 100 Shares of ABCD stock cost 100
and I buy a put for one year to have the right to sale it at 100
and the company goes to bankruptcy in the middle?
What would happen with my stocks and with the buy put.
Hope you can help me with this question.
Trading in the stock is suspended on the exchanges and moves to Over-The-Counter (OTC) or “Pink Sheet”
When this happened to Lehman Brothers in 2008, shares were trading at $0.05/share on OTC. Call options will expire worthless but put options will still retain value. Put options can be sold at their value or exercised and shares sold at the strike price.
Option trades are not with the underlying (bankrupt) company but rather with the person or institution that sold the put option.
These situations are quite rare but I understand the question in this market environment.
Good afternoon, thanks a lot for your answer.
It is very helpful.
Do you Allen or anyone think it is too early in the option cycle to purchase and sell calls with inverse
Entering trades for the new contract month on the Monday or Tuesday after expiration Friday is encouraged for our 1-month obligations. This is due to the negative impact Theta has on the time-value components of our premiums.
When there are critical events that may impact our investment decisions scheduled in the first week of a contract, a meaningful case can be made to allow that event to pass. Such an event is the Senate bill that has yet to be approved… hopefully tonight.
I am a Registered Options Principal(Series 4) with 35 years’ experience in the markets . I have come to the conclusion that the covered strangle strategy is an outstanding tool for small investors to generate income , particularly after the recent huge selloff in the markets .
My question for Alan is whether he has developed a screener for stock candidates priced under $5 per share that have either weekly or plain vanilla puts and calls available to sell .I have just signed up for the Newsletter and , if Alan has a screener similar to what I seek, I would be willing to pay to subscribe to it . Otherwise , I would appreciate his thoughts on the subject .
This is a good question that has been asked of me in the past. It motivated me to write an article about this strategy where both covered call writing and selling cash-secured puts are combined for the same underlying:
My personal preference is to favor covered call writing in normal-to-bull market conditions where we can take full advantage of OTM strikes and put-selling in bear and volatile markets where we sell OTM puts to either generate cash or to enter a covered call trade. Stock selection, option selection and position management can be tailored to craft the trades based on current market conditions.
Now, the BCI screening methodology is quite rigorous. We use fundamental analysis, technical analysis and common-sense principles (like minimum trading volume, avoiding earnings reports etc.) to generate watch lists of elite-performers from all perspectives. As a result of these requirements, a stock priced under $5.00 (penny stock) is almost never on our list. Therefore, the BCI membership is not going to meet your needs.
Most broker platforms have their own screening platforms (as I’m sure you know) and there are free services like finviz.com where we can set our own parameters, including price-per-share.
Please keep in touch.
Thank for the great service you are providing. I would like to be presumptuous and ask if you would review my first attempt and evaluating three put sale opportunities: two on T and one on BABA using your table..
Today’s date 3/24/2020
Stock Symbol T T BABA
Stock Price 27.2 27.69 186.9
Expiration Date 1/15/2021 1/15/2021 1/15/2021
Strike Price 28 23 187.5
Put Premium 4.35 2.08 9.15
Premium Collected per contract 435 208 915
Cash required per contract 2365 2092 17835
Return on Optionn if unexercised 18.39% 9.94% 5.13%
Stock Cost Basis/Break Even 23.65 20.92 178.35
Purchase discount if exercised
Number of days in trade 298 298 298
Annualized return on option 22.53% 12.18% 6.28%
Thank you very much
Evaluation of the suitability of a trade is based on our personal trading style and goals. What is our return goal range? Are we willing to take possession of the shares? What time-frame commitments are we willing to undertake.
My personal preferences as they relate to selling cash-secured puts include only OTM puts, 1-month time-frames (allows constant re-evaluation of bullish assessment and avoiding earnings reports) and a 2% – 4%, 1-month initial time-value return goal range.
Each investor must evaluate which trades are right for them based on the parameters I mentioned.
Alan, thank you for your response. I really appreciate it.
I was curious if my evaluations were structured properly and specifically if the returns were figured properly.
My rationale for long maturities relates to the downmarket and recovery times.
Yes, your calculations are spot on. See screenshot below.
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Do you have any article / video on buy put to protect against gap down? same question for the “collar strategy” ? also when do you recommend using these?
Here is a link to an article I published on this topic:
One third of this book is dedicated to the protective put/collar:
This is a link to the BCI Collar Calculator:
We will have a streaming online DVD Program dedicated to the collar strategy a bit later this year.
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Alan and the BCI team
I am writing you from my home prison.
I pretty much got it wrong all the way down. When I wrote you last, I was to slow to act and got just out of some contracts in time. The rest plunged down about 10%. I was hoping for a rebound to lessen losses, which never came, straight down since then. The inverse ETFs I am not allowed to trade. Now that we had the first significant bounce, I would like to insure against further losses by maybe buying some Put options. In that case do your suggestions regarding open interest and spreads between bid and ask hold as well.
If what I see here, can be translated to other countries as well, we are in for a mega recession, something we haven’t seen before. Everything is shut down, no job, no people on the street and no more civi rights. This is serious stuff.
I am not concerned about the virus, but it’s consequences and the general bad management.
Most economists agree that a recession is imminent. Many speculate that we can recover quickly depending on how the crisis is handled. We have several state governors that are shining in their handling of the situation but badly lack resources. Science is working on a vaccine and there are several promising trials taking place as I type. The final chapter on management has yet to be written but has to make a huge recovery.
Because of the unknown impact the coronavirus crisis will have on our economy/stock market, I am testing a Delta-neutral portfolio with ITM call options. I will share with the BCI community how that plays out.
Yes, the guidelines we use for option liquidity applies both to call and put options.
Stay safe and healthy in your home prison… better days ahead!
I’d like to get your thoughts on this:
• I bought LEAPs on Shopify expiring in 2022 with a $300 strike price
• On Monday when shares were trading at $374, I sold covered calls against this position and captured $1800 per contract for the $390 calls expiring this week.
• The stock price has since gone up dramatically and my LEAPs increased sharply, offsetting the loss on the short calls
• Now, I rolled out and up to the next week from $390 to $400 and generated an additional small credit of $50 per contract
• I did the math and despite the short call option being in-the-money, I still generate $1500 in time value per contract over the next 8 days.
Given the volatile market environment that we’re in, this strategy seems a viable way to generating time value and getting downside protection of that profit. Also, because of time value erosion I can still lift my strike price little by little every week if I want to. Also, I can still roll out to the longer expiration dates.
Is this correct?
When a stock price rises exponentially as has SHOP, and we are using the PMCC, initiating our trade using the required formula is critical:
Difference between the strikes + initial short call premium > cost of LEAPS
This way, if we are forced to close because both strikes are deep in-the-money, we can close at a profit.
You are correct, especially in times of extreme volatility, we can still generate time-value premium with deep ITM strikes. I did just that with my deep ITM strikes I’m using with my April Delta-neutral portfolios. The short call remains the active leg of position management.
Are you still 50-50% bullish ETFs and SHs? The market has recovered quite a bit so I am tiptoing into ETFs (SMH, XLB, XLV) and will look at QDEL next.
Yes, that is how I structured my portfolios (50% cash) for the April contracts.
I am hopeful, but not convinced, that we have an established bottom. I remain prepared with our exit strategy tools to adapt to new information as I did last month when I moved to inverse ETFs.