Most investors view covered call writing as a singular strategy where we buy a stock and then sell an option leveraging that security. In reality, educated option-sellers realize that one of the most remarkable advantages of using this strategy is that it can be crafted to achieve multiple goals and meet the trading style and personal risk-tolerance of a wide range of investors.
Given my medical background, this reality made me think of steroids, an anti-inflammatory that has so many uses. This miracle drug can be utilized to treat arthritis, bone diseases, gout, muscle diseases, blood diseases and so much more. To think of steroids as simply a drug that decreases inflammation is not doing it justice. In this same regard, this article will summarize some of the ways covered call writing can be designed to meet the needs and goals of a wide range of investors.
Covered Call Writing: The Steroid for Investors
The many uses of covered call writing summarized (hot links provided for products and more information)
- Traditional covered call writing: We buy a stock and sell an option using stock selection, option selection and position management as the 3-required skills needed to get started. Our portfolios turn over frequently.
- Portfolio overwriting: Covered call writing our buy-and-hold portfolios using only out-of-the-money strikes with lower initial time-value return goal ranges.
- Collar strategy: Covered call writing with protective puts. Bernie Madoff called this the split strike conversion strategy… let’s not go there.
- The Poor Man’s Covered Call (PMCC): Covered call writing using deep in-the-money long-term (LEAPS) options as stock surrogates.
- Covered call writing with ETFs: A more conservative approach to covered call writing using less volatile securities requiring less capital investment to achieve appropriate diversification.
- Covered call writing to create a FREE portfolio of large-cap tech companies: Covered call writing blue-chip (Dow 30) stocks to purchase shares of Invesco QQQ Trust.
- Covered call writing to convert non-dividend stocks to dividend-like securities: Using 4 trades per year to convert stocks that offer no dividends to simulate stocks that offer quarterly dividends.
- Stock repair strategy: Sell call options against both shares and long calls to reduce the breakeven price point when stock prices are in losing positions.
Discussion
Covered call writing, much like steroids to patients, can be tailored to meet the needs of investors in a myriad of situations. Limiting its application is not doing justice to the potential this strategy offers to those of us seeking to become CEO of our own money and ultimately to achieve financial independence.
Free webinar
I have cancelled all my in-person presentations through the end of the year due to the coronavirus crisis. To keep in touch with our members, we have decided to provide our BCI community with a free webinar in August. Feel free to send in topic ideas and suggestions. Send to: [email protected].
FREE WEBINAR JUST ADDED Thursday August 13th
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Alan Ellman is inviting you to a scheduled Zoom meeting.
Topic: FREE WEBINAR Hosted by The Blue Collar Investor
Time: Aug 13, 2020 08:00 PM Eastern Time (US and Canada)
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Meeting ID: 933 8656 0621
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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 want to tell you that your premium membership and all your teachings are fantastic! I have tried many other option sites, but yours explains the concepts very clearly and thoroughly using examples. Also, the premium membership is very affordable. I hope to be very successful making money using your techniques.
Thanks for offering this information to investors like me.
Raj
Upcoming event
Private webinar (California investment club)
Covered Call Writing with 4 Practical Applications
Saturday September 17th
9 AM – 12PM PT
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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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Hi Allan,
I was watching your training videos on exit strategies and was not clear about how to decide between rolling down immediately or waiting to hit a double on a stock that declines in the middle of the contract cycle?
I would appreciate if you could clarify.
Thanks,
Raj
Raj,
Here are the BCI guidelines:
1. Favor waiting to “hit a double: in the 1st 2 weeks of a 4-week contract and in the first 3 weeks of a 5-week contract.
2. Favor rolling-down in the final 2 weeks of a contract.
These are guidelines as there are exceptions. For example, I recently published trades I executed in the final days of a contract during volatile market conditions when I actually “hit a double” during the final days of a contract. Generally, 1 & 2 are the guidelines we should follow.
Alan
Alan,
Thanks, that clarifies the techniques. I enjoyed your PMCC course – hope to be taking others to refine my techniques.
Raj
Alan,
What do you do if a out of the money option gaps down on expiration Friday and it has earnings the next week.
Thanks
Mike
Mike,
The BCI guidelines for a stock with an upcoming earnings report are:
1. We usually remove the stock from our portfolio prior to the release to avoid the risk of a disappointing earnings report.
2. There are rare exceptions when we have confidence in a favorable report and want to keep the stock in our portfolio. In this scenario, we do not sell the call option until the report passes.
In the specific case of a stock declining on expiration Friday, we can check the news to understand the gap-down. If we decide to hold the stock through the earnings report, it must be based on sound fundamental technical and common-sense analysis without any emotional component. It’s the cash, not the stock, that is our primary focus.
Alan
Mike,
remember, even favorable earnings do not guarantee that the stock will not gap down after the report.
Roni
Roni,
Also a good wait of 2-3 days after favorable earnings to allow the price to settle is good advice.
Mario
Mario,
I agree 🙂
Roni
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 08/07/20.
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:
http://www.youtube.com/user/BlueCollarInvestor
Since we are starting 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/
The BCI team has added additional information, improved the format of our weekly ETF Reports, enhancing the quality of these reports, and making them more user-friendly and time-efficient. Here is a link to a video overview of these new upgrades:
https://youtu.be/-wgqoyjP5bQ
On the front page of the Weekly Stock Report, we now display the Top 10 ETFs, the Top 3 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.
Best,
Barry and The Blue Collar Investor Team
[email protected]
Dear Alan;
I am a premium member. The BCI recommends diversification with no one stock being more than 20% of ones portfolio and be in diversified industries.. It also suggests that rather than invest in the SPY itself rather choose the three top SPDR Select ETF’s. However this does not meet the same diversification requirements as the SPY does.
So in addition to the 3 or sometimes 4 SPIDER Select ETF’s that the BCI recommends should we also have 2 other stocks or ETF’s from other sectors to be better diversified? Initially I just held the SPY and QQQ options and have switched from the SPY to the SPDR Select and the QQQ.
Thank you.
Donna
Donna,
Your approach makes good sense.
Select Sector SPDRs represents a much broader classification than industry groups. “Industries” represent specific groups of companies whereas “sectors” represents large segments of the economy.
By owning 3 Select Sector SPDRs + the Qs, we own nearly 30% of the entire S&P 500. That is fabulous diversification.
Keep up the good work.
Alan
Hey Donna,
I used to have a holding page that would not fit in one screen print. I had a dog’s breakfast of stuff in the name of “diversification” or maybe more likely chasing the latest hot tickers :)?
I have simplified it a lot since then, I can now see it all on one screen :). The more I keep cleaning house the more I suspect if I just held long term something like 40% SPY, 30% QQQ, 15%% TLT and 15% GLD overwriting each for just under 1% a month I could stop all the circular over trading and still be overweight in the growth area of the market. If something gets called I immediately start a cash secured put campaign at the called strike to get paid to wait on when it comes back to me.
I suspect all my other hobbies and interests would benefit from my reduced tape watching :)! – Jay
Alan,
Can I ask which of the strategies do you persoanly use that you talk about in the article? I guess start with tradiional?
Thank you.
Jorge
Jorge,
I do favor traditional covered call writing in my portfolios and covered call writing with ETFs in my mother’s portfolio. All the strategies I mentioned in the article are viable strategies (there are more as Mario suggested in his post) depending on strategy goals and personal risk-tolerance.
Alan
Alan,
Just noticed you updated the August Blue Chip report on website to correct the 3 month / 1 year performance from 32% / 8% to 12.35% / 6.1%.
It is listed as Rev.A but the filename when downloaded did not change to Rev.A.
Perhaps I missed your notice to users that you updated it.
Mario
Alan,
Thanks for your very informative blog on the many uses of covered call writing this week. Makes a good printed checklist for strategies to consider as we begin and also do position management during a cycle. Powerful list.
To my checklist, I have also added Cash Secured Puts (CSP) with your Put Calculator 2019 (Version 2.0) available in Member Resources. You also mention CSP writing and the Put calculator in your discussion of the QQQ ETF for a portfolio of large-cap.tech companies.
Hope you do not get any requests for tablets!
Mario
Not yet…
Alan,
I am almost finished with your encyclopedia and must tell you that for the first time I can honestly say that I understand options. Thank you for writing this book. I plan to read it again and then get your other books.
I do have a question about closing (BTC) the option for exit strategies. What happens to the buyer of our option if he does not want to sell it?
Thanks for all you do.
Sy
Sy,
When we sell our options, it is not to a specific person. The Options Industry Council (OCC) matches up buyers and sellers for each trade. If and when we take a secondary action on our position, the OCC will match that action with another trader. Here is a link to an article I previously published on this topic:
https://www.thebluecollarinvestor.com/options-clearing-corporation-guaranteeing-our-options-trades/
Alan
Hi Alan,
I´m a new member and there´s lots to learn, and lots of good information from you and team!
My question relates to “Downside Protection” and “Break Even”. I know that they are not the same ideas in practice.
My question relates to the fact that when we close a position there will always be the buy back (Ask). So is it really Break Even or Downside Protection or are these more like warnings that as we approach the percentages we should be extra vigilant.
Am I missing something?
Thanks.
Jeff
Jeff,
No, you’re not missing anything. The 2 terms help us define the initial trade structuring but do not necessarily indicate a call to action.
Breakeven is the price point where gains equal losses. It is stock price minus entire option premium. It does not mean we close the short call but gives us a framework where our trade is at that point in time or where we would be if the stock traded at this price at expiration..
Downside protection is the intrinsic-value component of the ITM option divided by the stock price. It is the percentile amount a share price can decline while still generating the entire initial-time value return or where we would be if the stock expired at that price (the strike price) at expiration. It also is not a flag to close the short call.
In our BCI methodology, the guidelines that assist us as when to close the short call are the 20%/10% guidelines.
Alan
Hi Alan, quick question.
I am seeing some trades on your BCI reports that look promising for Covered Calls. However, they often have less than 100 Open Interest at the relevant strikes. But I also see Bid Ask spreads of less than .30.
Do both of these conditions need to be met to qualify the trade? Or is it one or the other? And if one of the conditions is met, does the trade then qualify?
Thanks,
Dave
Thanks for you feedback. I really enjoy your program!
Dave
Dave,
The BCI guideline is either… “a bid-ask spread of 100 contracts or more and/or a bid-ask spread of $0.30 or less”
Also, we should always take advantage of leveraging the “Show or Fill Rule” whenever possible:
https://www.thebluecollarinvestor.com/how-to-negotiate-better-option-prices-using-the-show-or-fill-rule-30-rebate-expiring/
Alan
Dan L.:
Noticed you commented in last week’s blog on Fidelity Active Trader Pro (ATP) regarding intrinsic and time value data in the platform.
I have been using ATP for 5 years but lately in the last 2 years have not used it much since I drifted to using the Chrome Browser for my stock and option trading so I could become familiar with trading at that level as well. (I likewise did the same with my Etrade trading – originally an Optionshouse platform user. Etrade later renamed the Optionshouse platform to Power Etrade after their company purchase.)
I did not notice the intrinsic and time value problems you mention with ATP but there apparently is an issue in the latest revisions as you mention. I provided a lot of feedback to Fidelity on their ATP, browser and Mobile apps. I like the fact they have an active development team that comes out with revisions with new features and fixes.
You are the only one I have noticed that uses ATP in this blog over the years, but I am sure there are others that have not posted comments.
A feature that I like with Fidelity is the power with their watchlists and the features they added to support trading while using the watchlists. While using ATP platform, I like the fact you can go to same watchlists and make changes there. In order to not confuse the software, when I have ATP loaded, I make changes from there and not also go to the browser to make changes. That way it stays synchronized properly. I like the fact you can add option symbols easily.
Found some good tricks to add options to the watchlists easily in ATP without going to the option tables. You can modify and copy any existing options symbol to add a new symbol, even after expiration..
I use one watchlist (up to 50 symbols) to keep track of 4 different trading accounts (2 in Fidelity, 2 in Etrade) so I have a real time view during a trading day of all accounts and the total account value. I use 4 dummy Money Market accounts to track the cash value in each account. Works nicely.
Recent feedback I gave to Fidelity is the fact their Alerts, one triggered become inactive, so I have to re-activate them manually (for a 3% change increasing or decreasing , for example). Would be nice to have the options to keep them active. With Etrade they stay active so they do not need grooming.
Mario
.
Hi Alan,
I am enjoying utilizing the BCI again after so many years. Currently, I have been writing covered calls on ETFs. I have a question. Why is the ETF report delivered on Wednesday instead of Saturday?
Thank you for your help!
John
John,
Welcome back to our premium member community.
Creating these reports involve examining thousands of data points which have to be reviewed multiple times. Producing both reports over the weekend would be a monumental task for my team. Both reports are formulated over a 2-day time-frame.
To maintain the quality and accuracy of our reports for our members we produce the 2 reports on different days but on a weekly basis so the information provided to our members is up-to-date and as precise as possible.
Alan
Gap up opening. Big drop at close. Bearish engulfing pattern. Looks like top is in.
Terry,
yup, very strange sudden change.
Looks significant to me too.
Roni
Don’t bet on it. It’s a casino. Surprises me all the time.
Mario
Mario,
looks like you were right. At least up to this moment.
LOL – Roni
Hi Alan,
I’m a premium member. Thank you for all the knowledge you’ve shared. I just have a few more questions:
1.) On setting up stop losses, I read that you suggest selling the stock when the price falls to around 7-9%. Assuming 7%, is this based on purchase price? strike price? or breakeven? How is the computation different for OTM vs. ITM calls? For example:
a.) OTM – bought BCI at $29, sold $30 call for $1. Should stop loss be at 93% of 29, 30, or 28?
b.) ITM – bought BCI at $29, sold $28 call for $2. Should stop loss be at 93% of 29, 28, or 27?
2.) How does the 20%/10% rule apply if you come in late in the month? For example, if I sell the Aug21 call on Aug 10, should my BTC orders be at 20% (since it’s only been a few days), or 10% (since there are only two weeks left to expiry)? Also, does it make sense to setup 10% BTC orders for weekly calls?
3.) Several of the stocks on the watchlist seem to be overbought (like tech and mining stocks). Although the technicals are excellent, I’m not sure if they are likely to continue, or will they range trade, or correct. How do you decide whether to go ITM/OTM on these stocks (assuming the current market conditions)?
4.) I noticed in recent months that in most cases, when the BTC order is filled, the chart technicals also turn negative (both MACD and STO), and most usually accompanied by some bad economic news (jobs report, etc). Does this mean we should take losses and sell the stock vs. waiting for a rebound / chance to hit a double?
5.) Are you planning to hold any positions during the upcoming election?
Thanks in advance!
Ken
Ken,
Glad to help. My responses:
1. Based on stock price…both a and b…$29. Since we are in 2 positions, the first line of defense are the 20%/10% guidelines. Once the short call is closed, a reasonable guideline as when to sell the stock is in the 7% – 10% range. I use significantly under-performed the S&P 500.
2. In the latter part of a contract month, the 10% guideline applies. Yes, for Weeklys as well. It is not unusual to roll-down or even (sometimes) “hit a double” in the last 2 weeks of a contract.
3. The stochastic oscillator can remain in overbought territory for months. It is but one of multiple screens we use and only 25% of the technical indicators we consider. If the chart is all bullish with an overbought indicator, I will favor OTM strikes in a bull market environment. Right now, I am favoring OTM strikes 2-to-1 over ITM strikes. I am just not completely comfortable with the current market conditions to go “all in”
4. Exit strategy opportunities are based on the time to expiration. We may opt to look to “hit a double” early in the contract or roll-down later in the contract. The 7% – 10% guideline will assist in when to sell the stock.
5. Prior to the 2016 election, I moved to cash and will probably do the same this year. I am currently 50% in cash because of my market concerns. I am almost always 100% invested so this is an aberration. The only other times I was 100% in cash was in late 2008 – early 2009 and in 2016 for a few days. We all must stay within our comfort levels.
Alan
Alan,
Yes, I remember very well the 2016 election when you were in Cash. Earlier that year, after 4 months reading the Encyclopedia front to back and other Option books from the local library, I made my first covered call trade in April of 2016 in an Earning Cycle – not the best time for finding a nice selection of stocks to buy/write covered calls using the Premium Report. Position management challenged me to remember your guidelines and rollover techniques.
I later purchased the Cash Secured Puts and Vol. 2 of your Encyclopedia.
I have found that on Expiration Friday I require 1/2 hour at least per stock symbol that needs to be rolled for analysis and taking action, otherwise that 4 pm hour approaches fast and you run out of time.
Thanks for all the great help, guidance, and education you and the BCI team have provided over the years.
Mario
Mario,
I in this regard, you have been an integral member of the BCI community for years, so let me thank you for your invaluable contributions.
Alan & the BCI team