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What Do Bernie Madoff and Covered Call Writing Have In Common?

is my favorite stock investment strategy and is one of the world’s most infamous sociopaths. How can they exist in the same article title? This week, ABC-TV is showing a mini-series documenting the rise and fall of Bernie Madoff and his $65 billion Ponzi scheme. Madoff never actually ever invested the billions of dollars given to him by hedge funds, millionaires, charities and retail investors looking to secure their retirements. Instead he used the money for his own personal and power and put a title on how he pretended to accomplish the goals of consistent returns of 12% per year, even in years when the overall market was down substantially like in 2008. The name of his strategy was split strike conversion and it has a lot in common with with the caveat that we actually execute our trades.


What is the split strike conversion strategy?

On first glance, the name may appear impressive or even intimidating. In reality, however, it’s simply with a protective put. We know it as the collar strategy. It’s so simple: Buy a stock, sell an out-of-the-money covered call and buy an out-of-the-money protective put. We put a ceiling on potential gains and a floor on potential losses. Yes folks, this is the secretive strategy of that led to so many lives being financially ruined…amazing isn’t it?


Example of the collar aka split strike conversion

  • Buy 100 x Company XYZ at $48.00
  • Sell 1 x $50.00 call for $2 (covered call)
  • Buy 1 x $45.00 put for $1.00 (protective put)
  • Net gain on the option buy and sale is + $100.00 ($200.00 – $100.00) per contract
  • This brings our cost basis down to $4700.00 ($4800.00 – $100.00) per contract

Outcome if stock price surpasses the $50.00 strike price:

  • Shares are sold for $5000.00 ($50.00 strike x 100 shares)
  • Results in a profit of $300.00 ($5000.00 – $4700.00)
  • ROO = 300.00/4700.00 = 6.4%

Outcome if stock prices falls below the $45.00 strike price to $43.00:

  • Shares are sold for $4500.00  (not $4300.00) because of the protective put
  • Net loss is $200.00 ($4700.00 – $4500.00) = (-) 4.3%

Outcome if stock price remains at $48.00:

  • ROO = $100.00 ($100.00/$4700.00) = 2.1%

Chart of possible outcomes:  

Bernie Madoff strategy

Collar or Split Strike Conversion Strategy

Madoff’s twist

Madoff pretended to buy shares in a major index and then buy and sell options on the index itself. Index options are cash-settled unlike stock and exchange-traded fund options where shares can actually change hands. Perhaps this twist is what threw off some of the more knowledgeable investors like other fund managers…but it was probably simply and laziness to perform adequate due-diligence. Retail investors get a pass but shouldn’t some of the fund managers have taken a closer look? Anyone can make up a story.


Bernie Madoff

I’m a marine biologist


The irony of it all

This strategy could have worked in most market conditions. One percent per month is not a crazy goal especially in normal and bull market environments (where results should actually he higher). Of course, in a year like 2008, we will lose money, period, just not as much as most others. Had he just taken the time to learn the nuances of the strategy with or without the put aspect, he could have run a successful fund that made a lot of money for a lot of people and still been a legitimate hero to most. He could have remained rich, famous and idolized. Instead he sits in jail for his remaining years having ruined so many lives and families including his own. So sad.


Wide World of Options: Alan’s Radio Interview (Free)

I was recently asked by the Options Industry Council to be interviewed by Joe Burgoyne the Director of Institutional and Retail Marketing, for The Options Industry. My segment starts 22 minutes into the program and lasts about half an hour. Here’s the link to the show:

Enter event for free

Scroll down and click on arrow on left to start program.

Interview of Dr. Alan Ellman, President of The Blue Collar Investor Corp.


Upcoming live appearance

New York Stock Traders Expo

February 21st – 23rd

Marriott Marquis Hotel, NYC


Here’s me promoting me at the Trader’s Expo

Click here


Market tone

Global stayed volatile late in the week as markets began to price in a more moderate tightening by the Fed. A March rate hike now seems unlikely. Market volatility, as measured by the Chicago Board Options Exchange Volatility Index (VIX) rose to 23.38 versus 21.5 a week ago. This week’s reports:

  • Nonfarm payrolls rose by 151,000 in January, less than expected. Revisions to prior months also subtracted 30,000 jobs from last month’s total of 292,000
  • The unemployment rate dropped to 4.9% from 5.0%
  • Average hourly earnings increased by 0.5% in January, up from a flat reading in December
  • Fed vice-chair Stanley Fischer had a bearish tone saying that global market volatility could lead to a persistent tightening of financial conditions, which in turn could signal a slowing in the global economy that could affect growth and in the United States. This seems to the market’s expectations of barely any interest rate hikes this year
  • In his 2017 budget, President Obama has proposed a $10-per-barrel tax on oil companies. The tax would be used to fund infrastructure and transportation projects. The measure is unlikely to make it through Congress

For the week, the S&P 500 declined by 3.10% for a year-to-date return of – 8.02%.


IBD: under pressure

GMI: 0/6- Sell signal since market close of December 10, 2015

BCI: After two positive weeks, we had a down week, confirming that the market has yet to establish a firm bottom. 1/3 of my stock investment portfolio remains in cash short-term. Favoring only deep out-of-the-money puts and in-the-money calls on active positions. 

Best regards,

Alan ([email protected])


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.

24 Responses to “What Do Bernie Madoff and Covered Call Writing Have In Common?”

  1. Ira February 6, 2016 4:00 am #


    I have a suggestion you may wish to consider in your Covered Call management process to Un-Cap the upside when a stock price moves up to the Short Call.

    Place a Back-Month Synthetic Long Stock combo and sell a Front-Month new higher OTM Call against it.

    You will probably have a small credit on the Synthetic as well as the credit on the new short Call. These credits provide a cushion in case the stock reverses direction. Use the Break-Even of the new position as a stop-loss in this case.

    I would suggest trying this if the move occurs within the first two weeks of the expiration period and only if the market technicals support the directional trade.


    • Alan Ellman February 6, 2016 8:04 am #


      I admire when our members think “outside the box” The general concept is how to take advantage of a situation when a stock has appreciated beyond the short call strike to take advantage of potential additional share appreciation. Rolling up in the same contract month will result in a debit and placing a synthetic long stock trade is close to a breakeven (I believe a slight debit…please check examples).

      I never roll up in the same month because we have maxed our trade and the success of the roll-up depends on continued share appreciation of a stock that has significantly appreciated already…too risky for me.

      The synthetic long trade (buy an at-the-money call and sell an at-the-money put using the same strike and expiration date) exposes us to unlimited risk on the downside starting immediately. There is no protection of this position even if we were able to establish it at no cost. There is also unlimited upside but is that potential worthy of that risk?

      Here’s what I do when a stock has significantly risen in value after entering a covered call position: I use the mid-contract unwind exit strategy and close the original position when time value of the premium approaches zero and then use the cash generated from the stock sale to enter a new covered call position with a different underlying, usually with an in-the-money strike (see pages 264-271 of the original Complete Encyclopedia and pages 105-107 and pages 243-252 in Volume 2).

      Keep those ideas coming!


    • Jay February 6, 2016 8:10 pm #


      My hat is always off to anyone who can recommend a Back-Month Synthetic Long Stock combo and sell a Front-Month new higher OTM call against it in the same sentence coherently :)!

      Evokes nostalgic days when we worried about OTM covered calls getting over run :)?

      This is a scary time to get started in covered call writing. Knowing what I do if I were brand new I would do nothing. You don’t want heart break on first dates.

      Only exception would be if you already own shares in 100 increments and want to sell some calls as protection. Just be sure you would be OK coughing them up at these levels if we get the over due bounce and you do not buy back to close.

      If any of you are new to options selling keep the faith. I almost lost my faith in 2013. I was selling calls while my investing friends beat the tar out of me holding mutual funds and leveraged ETFs on biotech, internet and health care. I felt like the dumbest guy in the room. Make no mistake, in 2013 I was!

      But things even out. If you focus on cash flow generation with half your money and invest the other conservatively your chances of disappointment diminish. – Jay

  2. Sara February 6, 2016 8:13 am #


    Do you think madoff’s fund would have become as big as it did if he traded this collar strategy legitimately?

    Thanks for the explanation.


    • Alan Ellman February 6, 2016 11:51 am #


      I believe the fund could have been hugely successful if appropriate trades were actually executed but would not have received the amount of investment dollars as the Ponzi Scheme. The major hook was that he professed to make money even in the most dreadful of markets…he was a self-proclaimed “magician”

      For example, in the mini-series during the 2008 crash, he tells his insiders (I’m paraphrasing) “let’s pretend we’re making 5% this year”


  3. Barry B February 7, 2016 1:32 am #

    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 02/05/16.

    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:

    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:


    Barry and The BCI Team

  4. Marty February 7, 2016 8:09 am #


    I know and use your rules for picking call strike prices but do you have rules how to select a strike price for the put if using a collar?

    Thanks for your help.


    • Alan Ellman February 7, 2016 12:16 pm #


      The rules (I prefer the term “guidelines”) for put strike selections are based on the same fundamental guidelines as those for call strike selection.

      Generally, we sell an OTM call and buy an OTM put, usually netting an option credit. The put will protect against catastrophic loss…it’s an insurance policy that we pay for. Now, the more concern we have for our position and therefore the more protection we want to buy, the closer will be the put strike to current market value of the stock. Depending on the choice, the option side may end up netting “0” or even a debit.

      Related to your question…here is a link to an article I recently published titled “The Zero-Dollar Collar”:


  5. Sean February 7, 2016 1:20 pm #

    Hi Alan
    I am trying to figure out where Bernie Madoff went wrong, as collar strategy is one of the safest there is.
    Is it that he traded Indexes that are European style options?
    So instead of STX he should have used SPY?

    • Alan Ellman February 7, 2016 1:32 pm #


      He went very wrong by never executing one single trade…everything was fake…a Ponzi scheme. His (limited) team of sociopaths created false brokerage statements claiming to generate 12% per year, even in extreme bear markets, even though one trade was never executed. He was executing trades in the same way George Costanza was a marine biologist (hope most of our members watched Seinfeld).

      Had Madoff actually taken the time to learn the strategy and then trade responsibly, he could have created a successful fund that would have helped, rather than ruin, thousands of families.


  6. Jay February 7, 2016 6:39 pm #

    The time stamp keeps me honest: I hope Peyton gets one more tonight and rides off into the sunset. Cam will have plenty of other chances…

    Great trading to all this week. Happy Mardi Gras from down here in good ‘ol New Orleans. – Jay

  7. Adrian February 8, 2016 4:39 am #

    Alan, Last time I had asked about whether the $5 strike price gaps on some stocks were risker to hold than the strikes with a lesser gap to them, as they being less liquid.
    Even though you say $5 strikes are normal, then is it alright for me to include a scan of stocks that have only up to $2.50 strike price gaps instead,- or is this not really a good idea?

    Other questions on this same topic I have are:-
    2. When looking at the options chain for ‘XLP'(alongside others) there is less ‘O.I’ for the strike prices that end in .50c (eg. $49.50, $50.50, etc), compared to the other strikes without the .50 on the end. Would you say this because the round number strikes like $48, $49, $50,etc are more popular and hence less risky to use?

    3. As I have been using ETF’s for this month, then would you suggest for us to at least try to have a minimum amount to use – like a number of at least 3 or 4?

    4. And to find out what an option price was at in the past, or if it’s correct you once said I can check the options chart on ‘’. But the option charts only have the middle ‘last-sale’ price(which may have been hours back). So how could I find out the Bid or Ask prices now – to reflect the current share prices?
    Thank you

    • Alan Ellman February 8, 2016 12:05 pm #


      1- Screening for securities with $2.50 strikes may be too limiting. These usually apply to lower-priced stocks. I would do a more conventional screen and THEN screen for $2.50 and see if you find enough candidates that meet your goals. If not, move into the more conventional pool. ETFs which generally trade in $1 increments will meet your needs in this regard.

      2- Increased supply and demand has introduced $0.50 strike increments in some of the most popular securities. I would suspect OI to be lower for these newer products until traders become more accustomed to seeing them. Maybe they just don’t want to deal with the math? You will, however, see some exceptions to this observation.

      3- This depends on the diversification of the ETFs. 2-3 SelectSector SPDR ETFs are much more appropriate for a covered call portfolio than 10 gold ETFs.

      4- Historical options data is my nemesis. Generally, this information is reserved for institutional investors by vendors like Bloomberg and Reuters at costs prohibitive to retail investors like us. Here is what I have:

      FREE site:

      Enter stock ticker in search box, upper right

      Click on “options” in middle of page

      Find strike and click on “quote” on the left side

      Graph of price history appears

      Can add a ticker of a stock or index for comparison

      If any of our members know of any free or low-cost venues to obtain historical options data, please post on the blog or send me an email.


    • Barry B February 8, 2016 5:35 pm #


      For historical options pricing, you can get end of day prices for any option using ThinkOrSwim’s platform. You can use the “Think Back” function. It will provide you with the information that you need. They have a no cost “Paper Trading” account you can open, but i don’t know how long they will allow you to use the platform without funding an account. As i recall, it was about thirty days. Also, be prepared to invest a decent amount of time to learn the platform. ThinkOrSwim is a professional level trading platform.

      They also have a feature that will give you intraday historical options pricing, but you will need a funded account and a lot of time to learn how to use the tool effectively.



  8. Alan Ellman February 8, 2016 10:15 am #

    New seminar just added:

    Austin, Texas

    Monday October 24, 2016 (evening)

    Details to follow.


  9. Earl February 8, 2016 11:46 am #

    For the past while after a purchase of stocks, the stock price has often dropped before the contract is due, so even with out of the money covered call sales the price is too low to sell the stock without a loss. If the stock is no longer on the recommended list in your weekly report, do you suggest the stock be sold at a loss and buy a new one that is on the recommended list or just wait until the stock rebounds and sit out until then? Or perhaps sell a new call and if the price rebounds potentially then let it go?

    Thank you.

    • Alan Ellman February 8, 2016 12:21 pm #


      There are two separate questions here:

      1- How do we manage our position when share price declines?
      2- Do we stay with an under-performer in the next contract month?

      My responses:

      1- When share price declines, we use the 20%/10% guidelines to buy back the option and (perhaps) roll down if share price does not recover. This will generate additional time value premium and offer additional downside protection. If the stock substantially under-performs, we may decide to sell the stock as well and enter a new position, sometimes mid-contract. In essence, we are mitigating losses as the price declines.

      2- If we still own an under-performer at the start of the contract month we must realize that it’s the cash we have invested in that security that we care about, not the stock itself. In which stock does the remaining cash have the best prospect to grow? Usually in another security.

      Management is critical. It’s been challenging of late because in the past several weeks, the markets have been unusually volatile and bearish. In normal market conditions, our management skills will not be tested to this level.


    • Jay February 8, 2016 4:43 pm #


      My friends tell me I am too simple :).

      Where do you think the S&P will be a monh from now?

      If you say higher buy stocks and do not sell covered calls. Sell cash secured puts for income.

      If you say lower do not buy any stocks. Sell ITM calls on the ones you own.

      Alan and I could have a lively debate on the topic. But to me you have to get the market direction right first. – Jay

  10. Alan Ellman February 9, 2016 1:36 pm #

    Radio Interview just added:

    March 15, 2016 at 9 PM ET

    Solutionsology Radio Interview

    Details to follow


  11. Adrian February 10, 2016 5:21 am #

    Thanks Alan/Barry for your generous comments, and so as I have been using for the options prices intraday maybe then as Barry says the Thinkorswim platform is a platform worth me looking into using. It’s great if there is an options chart for the intraday prices, but the last-sale price that is charted could be the Bid or Ask or any price in between.
    It would just be reassuring that the brokers are giving me out honest prices at any time of the day wouldn’t it? (have a question on that one soon.)
    Thinking I will include a screen up to $2.50 strikes after the normal screens, just as long as there are enough leftover, – 7 out of 9 stocks I found were up to $2.50 strikes so that’s got to be good!
    There has always been a feeling with me that using just 1 ETF won’t be safe enough even if quite diversified, so I will do as I have been doing and keep using at least 3 as my minimum. Thanks

  12. Alan Ellman February 10, 2016 10:18 am #

    Strike selection:

    I’ve had a few questions on this topic lately from some new members and thought I’d share my response with the entire BCI community:

    Strike selection depends on:

    • Time value returns goals (mine are 2-4% per month)
    • Overall market assessment Bullish, bearish etc.)
    • Chart technicals
    • Personal risk tolerance (I use a goal of 1-2% per month in my mother’s account)

    As an example, I ran the calculations for March 18th expirations for FISV (see spreadsheet below). If bearish, I would lean to the $90 strike where we generate an initial time value 5-week return of 3.3% and a 2.3% protection of that profit (different from breakeven which is $86.99). If bullish, I would lean to the $95 strike which generates an initial return of 2.5% along with an opportunity of an additional 3.2% if share price moves up to the strike by expiration. I have been using a lot of ITM strikes since the downturn in the market. Once a position is entered we must be prepared with our exit strategy arsenal (20%/10% guidelines etc.). The 3 required skills are:

    • Stock selection
    • Option selection
    • Position management



  13. Jeff February 12, 2016 11:18 am #


    Your fictitious collar example provides deceptive return potentials. Use a real-world example and you’ll see why.

    Here’s one I just did on the Dow stock closest to the $48 stock in your very misleading example:
    Buy 100 MRK @ $48.50
    Sell 1 Mar2016 $50.00 Call @ $.84
    Buy 1 Mar2016 $45.00 Call @ $.67
    ARIS (Annualized Return if Static): +3.5%

    Covered Calls provide higher return potential than Collars since buying Puts degrades the return potential.

    Stick with Covered Calls!


    P.S. I challenge you to provide an example using a real stock!

    • Jeff February 12, 2016 11:20 am #

      Oops! In my Merck example, I should have said
      Buy 1 Mar2016 $45.00 Put @ $.67

    • Alan Ellman February 12, 2016 1:17 pm #


      Perhaps I wasn’t clear as to the intent of this article. I was highlighting the fact that Bernie Madoff’s split strike conversion strategy was simply a collar. I gave a generic example showing an option credit and debit. I was not commenting on potential returns of a collar other than to say that 1% per month was certainly possible in normal market conditions. Initial returns showed in the example was not the focus as that would be an exercise in futility as returns can vary greatly based on the implied volatility of the underlying security and the two strikes selected.

      In my 6 books, 3 DVD programs, over 300 journal articles and 250 videos I have made it abundantly clear that I do not use collars but there is nothing wrong with it. We have many members who do use collars and I respect their decision to do so because it meets their trading style and personal risk tolerance. One size does not fit all and I would never make a blanket statement regarding any strategy or how it is managed.

      Now, there is no need to challenge me…that’s not what this site is about. We are here to help and learn from each other…a two-way street. I will, however, provide an example with the caveat that collar calculations have nothing to do with this article or its intent and that initial returns depend on factors I alluded to above. GDX is an ETF I have been discussing recently. I captured a screenshot of the options chain for the March, 18,2016 5-week expirations shown below. With the security trading at $18.26, I selected the $19 OTM call and the $16.50 OTM put. The net options credit (before commissions) is $0.41 ($0.98 – $$0.57) which represents an initial (static) return of 23.4% annualized. Adjusting the call and put strikes will change the static returns in either direction. Once again, this example was submitted for educational purposes despite the fact that collar calculations had nothing to do with the intent of this article.

      Thank you for allowing me to clarify the purpose of this article, perhaps others misunderstood as well.



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