In June 2018 I had the pleasure of having dinner with Kevin, a long-time BCI member and retired financial advisor. His story reminded me of how option-selling not only impacts the investor but also so many of those close to us. In Kevin’s case, it touched members of his family and a large database of clients. This site rarely invites guest authors to post but I felt that Kevin’s history with covered call writing would be both motivating and instructive to retail investors. I asked him if he would be willing to share his story with our community and Kevin generously accepted. During this holiday season and a challenging stock market environment, I felt that this would be an appropriate time to share this story. Now, Kevin’s memoir:
Covered call writing has had a profound influence on my life, the lives of my family, clients and friends over nearly 40 years. I am writing this to share my story with the BCI community.
My name is Kevin. I am a Bostonian by birth but Charlotte, NC has been my home for over 30 years. I am a retired Financial Services professional of nearly 40 years. During the period that I managed money for clients I used the covered call strategy to provide consistent returns, provide downside protection and steady income streams allowing my clients to retire with dignity and respect.
I first learned of covered calls in the early 1980’s. One day I overheard a colleague say he was writing covered calls for his clients. When I inquired about the strategy, he explained that he was selling Calls on stock the client already owned. He would sell a call at a price above the stock and if the stock price was above the option price (strike Price) at the end of 30 days the stock would be sold, and the client would keep the proceeds from the option and any appreciation of in the stock. He further explained that if the stock dropped in price the client was indemnified against loss equal to the Money (premium) he received for selling the call option.
This had an immediate appeal to my conservative nature and I began to write calls in my own portfolio. Little did I know what an enormous impact this would have upon my family and career.
As my daughters began to mature, expenses associated with their maturation began to consistently appear on the horizon.
First out of the box was the need for ortho denture. My wife returned home after a visit to our dentist. She was visibly upset about something She proclaimed that our daughters need braces for their teeth and how was I going to pay for it. My response, ” No worries” I will just sell some covered calls.
Over the next 10 or so years we covered expenses for automobiles, college tuition, weddings and countless other needs, real and imagined. I am happy to say our daughters were eventually able to join the workforce without debt. Needless to say, they have become covered call devotees.
Like many of you I had a wonderful Mom who sacrificed to raise my brother and I. When she retired, she had a small pension and modest savings account and Social Security. The sum total of her income sources was barely sufficient to meet her needs. Since managed her money I began writing OTM (out of the money) calls which provided and nice steady income to cover her living expenses. The calls I wrote were largely on Blue Chip Stocks that she was familiar with. Although she did not completely understand the mechanics of covered calls, she liked the extra cash and was so relieved that she came to refer to Covered calls as ” Pennies from Heaven”.
In early 2002, I had discussion with her about the need for long term care Insurance. After many discussions with her about the valid need for Long term care Mom refused to “spend all that money”. Knowing the futility of arguing any further, I just decided I would out flank her. Several weeks later I approached her again. This time I had to lie to her for the first time in my life so that she would agree to have a LTC policy. I explained to her as an executive with my company, that extended family, were eligible for long term care insurance. She said wonderful. Now the premium had to be paid. I submitted the application and for the next 10 years paid premiums annually using covered calls.
One day I received a call from my brother that “mom” had a stroke. I met with her doctor and what he had to say nearly knocked me down. He said “your mother will live maybe for a year. It is imperative to find a facility for her care after she is discharged from the Hospital. It will be expensive; does she have long term care?”
We were fortunate to find a facility very close to my home. My brother and I did an assessment of how much income she had and how much were here LTC and other cost would be. We quickly realized that even with her LTC policy and other sources that there would still be a monthly deficit. Once again, Covered Calls to the rescue. We were able to make sure my mother had the best of care because she had LTC (paid for by C.C.) and were able to easily cover any other expenses with covered calls. We were able to ” Hit a Double” as Alan Ellman would say using covered calls.
My mother passed away one year after her stroke. We were able to preserve all of her cash and brokerage assets because of the cash we generated.
2008 THE CRASH
In 2008 the storm clouds began to gather. Market volatility was rising rapidly, well-known companies were declaring bankruptcy and clients were frightened. My staff and I had been writing calls for years for our clients, but with the market dropping precipitously, we made a course correction as our clients continued to have the need for income but were frightened about having money at risk. We met with our clients and explained to them that we would continue writing calls but that we would be altering the covered calls by selling DIMs, Deep in the Money Calls. Their monthly cash flow would continue, and we might be called away more frequently but because were selling deep in the money calls they would be largely protected to the downside and that if necessary we would do this until the market turned.
So, while the market continued to fall, our clients cash flow never faltered and because of using ITM calls they suffered very little reduction to their portfolio values.
Hundreds of our clients had their cash flow intact and we preserved assets due to covered call competence.
Covered call writing has had a profound influence on the quality of my life and that of my family members and Investment clients. It is a strategy geared to the retail Investors and levels ” the playing field” between us and the Institutional investors. My hope is that this article motivates other retail investors to investigate this strategy to determine if it may improve the quality of their lives as it has for me and my family.
Kevin F. Crowe, MS
Holiday Discount Coupon Expires on 12/30/2018
For a 10% discount on all store items use promo code: holiday10
February 7th – 10th, 2019
Orlando Money Show
Omni Orlando Resort @ Champions Gate
February 7th – 10th 2019
1. Getting Started with Stock Options: Creating Monthly Cash Flow with Covered Call Writing
February 8, 2019, 3:10 pm – 3:40 pm
2. Getting Started with Stock Options: How to Select the Best Options in Bull and Bear markets
February 9, 2019, 2:00 pm – 2:45 pm
This week’s economic news of importance:
- Home builders index Dec. 56 (60 last)
- Housing starts Nov. 1.256 million (1.230 million expected)
- Building permits Nov. 1.328 million (1.265 million last)
- Existing home sales Nov. 5.32 million (5.17 million expected)
- FOMC statement & projections 2.25 – 2.50 (as expected)
- Weekly jobless claims 12/15 214,000 (218,000 expected)
- Philly Fed Dec. 9.4 (14.0 expected)
- GDP Q3 3.4% (3.5% expected)
- Durable goods orders Nov. 0.8% (as expected)
- Personal income Nov. 0.2% (0.3% expected)
- Consumer spending Nov. 0.4% (as expected)
- Core inflation Nov. 0.1% (0.2% expected)
- Consumer sentiment index Dec. 98.3 (97.2 expected)
THE WEEK AHEAD
Mon Dec. 24th
- Chicago Fed national activity index Nov.
Tue Dec. 25th
- None: Christmas day
Wed Dec. 26th
- Case-Shiller home prices Oct.
Thu December 27h
- Weekly jobless claims 12/22
- Consumer confidence index Dec.
- New home sales Nov.
Fri December 28th
- Chicago PMI Dec.
- Pending home sales Nov.
For the week, the S&P 500 moved down 7.05%% for a year-to-date return of -9.61%
IBD: Market in correction
GMI: 0/6- Bearish signal since market close of November 13th, 2018 as of Friday morning
BCI: Selling only in-the-money strikes; moving 25% of my stock portfolio net worth into cash. Still confident in the fundamentals of the US economy and plan to put the cash on the sidelines back to work once the selloff subsides.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
The 6-month charts point to a bearish tone. In the past six months, the S&P 500 down 12% while the VIX (30.36) moved up by 107%.
Wishing you a happy, healthy and safe holiday season,
Alan and the BCI team
Very rough first month to start my buy write program but I believe in the process over the long haul and plan to keep going. Wondering your thoughts on doing collars going forward until things settle down. If you have a chance to jot down your thoughts on that – that would be great.
Thanks and happy holidays.
Yes, the collar strategy is an excellent approach in bear and volatile market environments. It represents an insurance policy to the downside. This along with selling in-the-money call options and out-of-the-money put options represent tools in our arsenal to protect in challenging market scenarios.
For members not familiar with the collar strategy, our new book and calculator (package of 3 or individually) details this approach:
Maybe you could share your experience how you manage the market downfalls like this? Are you using 8% ‘stop loss’ rule for the underlying (I don’t remember where exactly I read about it, maybe in this site or in one of your books)?
Most stocks I own are down substantially wiping out the profits I made through the year selling covering calls and intuitively I want to sell deep out-of-the-money calls to capture the possible rebound, but premiums are low for far OTM strikes and I don’t know is it worth to sell them at all. BCI recommends selling only in-the-money strikes to protect stock from further downside. Is it a proper strategy to keep selling covered calls even after stock is down substantially? I know there is no one right answer, but when you are down with underlying, what do you usually do?
It is critical when markets behave in extreme conditions, up or down, to not veer from our established system. These scenarios are aberrations and we must not react emotionally but stick to our fundamental, technical and common sense principles. In the long run, this will serve us quite well.
We’ve all been hurt in the recent market downturn but many of us were impacted much worse in 2008 and those who stuck with the program (or other sound programs) have been rewarded handsomely.
When a stock declines in value, we use our 20%/10% guidelines and roll down to continue the process of generating cash flow to mitigate unrealized stock losses. If a stock is dramatically under-performing the overall market, we replace it with another from our most recent reports. Usually, another guideline used by investors guideline is a decline of 8% – 10% but that would fit most stocks recently.
Most stock owners do not sell options. Covered call writers have paper losses in these market environments, but less than those who do not sell options.
Finally,in my view, the economic fundamentals are in place for a recovery in the stock market. Trade concerns, rising interest rates, political concerns and global reactions to US policies have temporarily rocked the markets. But corporations are still doing well, and economic stats and consumer confidence is still humming along well.
I have taken 25% of the stock portion of my portfolio and moved to cash and remain 75% invested with stock options. I anticipate moving that cash back to work in the very near future.
One size does not fit all and each must investor must decide how we invest until the recovery. These decisions cannot be emotionally-based.
Better days are ahead so sit back, relax and have a great holiday season.
But if we roll down and underlying rebounds we’ll get assigned at the lower price and our loss will become real. Let’s say the stock was purchased at $200 and covered call premium initially sold was $5 lowering our cost basis to $195. Now the stock trades at $150 and we sell another ATM for $4. Our cost basis is $191 now. The next month stock is up to $200 again, but we got assigned at $150 with $50 realized loss. The premiums will decrease our real loss to $41 ($50-$9), but we lose in this situation anyway instead of just holding the underlying. This is what I’m fearing the most in current volatile market environment. For some stocks to cover the loss with cash flow premiums might take at least 10-12 months after the recent selloff and I don’t know if it’s better to keep selling covered calls or just leave it with paper loss hoping for rebound (and that can take many months too).
I understand your concerns.
First, we must define our strategy and investment approach. Overall, we want to make as much money as possible, that’s a given. How do we accomplish this? By selling options, leveraging underlying securities or by buying and holding shares? Long-term studies (see Ibbotson) show that (paraphrasing) “covered call writing slightly out-performs the overall market and with less portfolio volatility”. These results were accomplished without the stock selection process, option selection determinations and exit strategy arsenal we employ in the BCI methodology.
Now let’s get to your hypothetical example starting with the rationale assumption that nobody can predict the short-term movement of the market or any one security. We can, however, throw the odds significantly in our favor and that’s what the BCI methodology is all about. Some comments:
1. A stock dropping in price from $200.00 to $150.00, would have triggered multiple exit strategy executions before the sale of the $150.00 ATM call, probably also including selling the underlying which declined in value (25%) much more than the overall market.
2. Any exit strategy we execute is based on the current value of the stock, not on the price paid at some point in the past, whether that price was $200.00 or $10.00. If the share price is $150.00 and we are bearish still, sell an ITM strike. If predicting a recovery, don’t sell the $150.00 ATM call but rather an OTM call to talk advantage of that share appreciation.
3. When we have market aberrations, we should not change our strategy approach based on these anomalies, but rather stick with a system that has proven successful over decades of application.
4. Each investor must make decisions on the type of market conditions we are comfortable trading in. For example, for new option traders, this is not the best environment to get started. More experienced option-sellers have seen this “show” before and know that better days are ahead.
We have all felt the pain of the recent market decline. I feel it for myself and for all our members. My concern is that we don’t exacerbate these losses with emotional decisions. Let me conclude the same way I did on my previous response:
Better days are ahead so sit back, relax and have a great holiday season.
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 12/21/18.
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 BCI Team
I think in todays highly volatile and hence treacherous environment if you buy stocks to short C.C. then you are likely to earn just 1 premium.After that your stock will more likely tank and then either you sell a ITM C.C. to earn something but your stock can/will be taken away from you, overall you will be in minus or you don’t do any option trading, hoping and waiting for your stock to climb.
What else are your options??
I agree with you 100%.
By the time I realized that this was a major correction, and went fully ito cash, I had already lost more than half of my 12 months gains. Sniff, Sniff.
If I had insisted, it would be much worse today.
But I believe I have learned a very important lesson, and will never forget it, for the rest of my trading days.
When a position loss is at about 10%, you must unwind it immediately, because the odds are tilted strongly against you.
what a great story. Congratulations.
Especially how you managed to continue during the dramatic recession after October 2008 ? You must be enourmously skillful.
How do you determine how much money going into bond market.
One generally accepted financial rule of thumb is to subtract your age from 110. This is the percentage of your portfolio that you should keep in stocks, with the rest in bonds. For full disclosure, I, personally, am significantly higher in stocks and options.
Fear and Greed Index at an extreme!
great snapshot of investor’s emotions.
In my opinion, the best way to deal with these variations is to avoid the extreem greed fase (dark green), be fully invested in the light green period, and get the hell out of Dodge when fear begins to set in.
I wish I had been more fearful in late October 2018.
Fear is a healthy human reaction.
Recently l sold a naked Put Option on Skyworks Solutions at $80.00, which l got assigned to.
Now it has dropped to $63.00. Is selling ITM option calls still valid and what strike price do you recommend l sell a ITM covered call?
I can’t give specific financial advice in this venue but glad to make some general comments you may find useful.
When share price declines significantly from the purchase price, we must first decide if the stock deserves a place in our portfolio. Converting an unrealized loss to a realized loss is not a reason to keep a stock…it’s the invested cash that important.
If we are bullish on share price recovery, selling OTM calls which generate premium cash flow plus allows for share appreciation makes sense. If we are concerned about further price decline but still want to retain the shares, ITM calls make more sense.
We are currently experiencing a market aberration which makes investing more challenging but history and economic fundamentals tells us that better days are coming.
Hi Joe, your mention of SWKS got me curious about it since I traded it and owned it several years ago but had not checked on it in a while. I see it has had a wild ride along with it’s sector and tech in general. It is back up over 6% with broader tech today!
In only the unsolicited opinion of one hobbyist to another if you like the SWKS story, and I still think it is a good one, then just hold the shares. If you have 200 shares, perfect, write one contract of your choosing ITM or OTM and let 100 run.
The experience I had with semi chip, biotech, emerging market and other high beta stocks when it came to options selling was by their nature they were all over the yard volatility wise – good and bad! So they can leave you in awkward places at any given time when they are covered either by cc’s or csp’s.
I had to decide “am I in these as growth stocks or I am I in them for premium this month or next?”. If the answer is “both” you need at least 200 shares of any ticker so you can do both! All the best with SWKS. – Jay
If you look at SWKS chart, you can see it is dropping steadily since June 2018.
I would swallow my losses and get my money out while it is still possible.
I have not followed SWKS in some time but it used to be a “darling stock” a lot of people liked. I guess fads and fashions come and go :)? – Jay
Your comment reminds me of something someone, Roger McNamee, I think, “You should rent stocks, not own them”.
By that he meant that there was a season for every good stock. After it out performs the S&P for sometime, sometimes years, it can become dead money, if not a loser.
We seen plenty of those in tech: CSCO INTC, DELL etc. Speaking of DELL it resumed trading today on the NYSE.
Of course some stocks are for trading only. But usually we can do better with options on those stocks. Better not to rent or buy.
Hope you are doing well in this market.
Looks like we got a Santa Claus rally after all. Too late to pull me out of what has been my worst month ever.
Have a Happy and Prosperous New Year.
Hoyt, I feel your pain, 2018 was my worst year in a decade.I am a bit better off than the S&P because I had some cash positions, sold some options and bought some as well but it is not exactly a nourishing feeling to see the ‘ol nest egg go down.
High hopes for a better 2019 despite all the odds and cards stacked against it :)! – Jay
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Alan and the BCI team
How are you? I am writing you this message since tomorrow I might create a trade to roll a covered call option in case the stock price keeps going up.
This is my situation:
I created an order on 12/24/2018 for:
Order Type: Sold Short
Security: AMZN Dec 28’18 $ 1475 Call
So now the stock price is above the strike point and I do not want to sale the 13 contract.
Could you help me to design the rolling covered strategy for tomorrow/
And if you have more videos, calculator and examples about how to do it I will highly appreciate your help.
Thanks a lot
We can avoid exercise (99.9% of the time) by buying back the short calls prior to 4 PM on expiration Friday. The cost-to-close will be the amount the strike is in-the-money (intrinsic value) plus some time value component. The closer to expiration we are, the lower the time value amount due to Theta (time value erosion).
As of pre-market on Thursday, the $1475 strike is out-of-the-money but certainly can move in-the-money by expiration tomorrow. Should that occur and should you decide to roll the option, you must decide on both a strike and expiration date to replace the current short call. The “What Now” tab of the Ellman Calculator will be extremely useful in this regard. Rolling out-and-up is more bullish than simply rolling out.
Exit strategy execution (including rolling strategies) is critical to our long-term success and is a major part of all my books and DVD programs (exit strategy sections).
To everyone in the BCI community Have a Happy and Prosperous New Year.
May all your shorts expire barely out of the money and all your longs close deep in the money.