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Why are We Receiving a Higher Return When We’re Expecting a Lower Return?

On 2/21/2022, Frank emailed me about our 10-Delta ultra-low-risk cash-secured put strategy. With Moderna Inc. (MRNA) trading at $145.00 per-share, he asked about using the deep out-of-the-money $118.00 weekly strike that expired on 2/25/2022. Let’s evaluate this trade to see if it aligns with our strategy goals and personal risk-tolerance.

 

MRNA option-chain on 2/21/2022

MRNA Weekly Put Option-Chain on 2/21/2022

The 10-Delta requirement is met by the $118.00 strike (-0.992) and shows a bid-ask spread of $1.23 – $1.53. This is definitely a negotiable price but, for purposes of this article, we will use worst case scenario of $1.23 (published bid price).

 

Factor #1: Expectations of lower returns than normal: Monday is President’s Day creating a 4-day week

Let’s feed the option-chain data into the BCI Trade Management Calculator (TMC) to see if the initial returns meet our stated goals (let’s say 0.5% per-week, 26% annualized as a reasonable hypothetical):

MRNA: 10-Delta Put Calculations

The spreadsheet shows a 4-day return of 1.05%, 96.12% annualized (red arrows) with a price point of $116.77. If the option is exercised, MRNA would be purchased at a 19.47% discount from the price when the trade was initiated (blue arrow). This is certainly not lower-than-expected returns but, in fact, much higher. What is causing this skew in expected returns? Why is the implied volatility of MRNA so high this particular week?

 

You guessed it …earnings will be announced this week

 

MRNA Upcoming Earnings Report

 

Discussion

When selecting strikes for our 10-Delta ultra-low-risk put strategy, in addition to the 10-Delta requirement, we must also ensure the time-value returns meet our previously stated goal range. When the return is surprisingly high, we must check what event is causing this rise in expected implied volatility. In a majority of these instances, the cause is an upcoming earnings release and the trade should be avoided until after the report passes.

 

Your generous testimonials

Over the years, the BCI community has been incredibly gracious by sending our BCI teaemail 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,

Thank you so much for all the content you make.

My husband and I have been following you for the past eight years and have finally started covered call writing. We also just signed up for your monthly VIP, finished your for Students textbook & ordered the Covered Call Encyclopedia.

Thank you again for all you do!

Sincerely,

Cheryl & Ryan

 

Upcoming event

Money Show Orlando live event

October 30th – November 1st, 2022

OMNI ORLANDO RESORT AT CHAMPIONSGATE

Visit Alan, Barry and members of the BCI at Booth # 415

 

Sunday, October 30, 2022, at 5:00 pm – 5:45 pm EDT
Covered Call Writing: Multiple Applications Based on Current Market Conditions

Monday, October 31, 2022, at 4:30 pm – 6:30 pm EDT
Selling Cash-Secured Puts: Detailed Start-to-Finish Six-Part Program*

 

Masters Class

Comprehensive Course on Selling

Detailed start-to-finish 6-part program

This presentation will provide all the information, with real-life examples, necessary to master the strategy of selling cash-secured puts. The program is divided into 6 sections:

  • Section I:
    • Option basics
  • Section II
    • Traditional put-selling
  • Section III
    • PCP (wheel) strategy
  • Section IV
  • Section V
    • Ultra-low-risk put/Delta strategy
  • Section VI
    • Ultra-low-risk put/Implied volatility strategy

This presentation was developed to benefit both beginner and experienced option traders and will provide all the information needed to initiate the strategy and elevate returns to the highest possible levels.

45-minute presentation

Covered Call Writing: Multiple Applications Based on Current Market Conditions

Real-life examples with Invesco QQQ Trust (Nasdaq: QQQ)

Covered call writing is a low-risk option-selling strategy geared to generating cash flow with capital preservation a key requirement. This presentation will demonstrate how the strategy can be crafted to benefit in all market environments. Market situations highlighted are:

  • Normal to bull markets
  • Bear and volatile markets
  • Low interest-rate environments

A popular large-cap technology exchange-traded fund, , will be used to establish rules and guidelines to benefit in these market circumstances.

Registration link and more details to follow.

 

Alan speaking at a Money Show event

***********************************************************************************************************************

Market tone data is now located on page 1 of our premium member stock reports and page 1 of our mid-week ETF reports.

****************************************************************************************************************

 

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.

7 Responses to “Why are We Receiving a Higher Return When We’re Expecting a Lower Return?”

  1. Jeff July 16, 2022 1:15 am #

    Alan,

    Have you ever taken a “very early” 50% gain on the call instead of waiting for the 20-10% guide? It seems like the annualized returns are much greater. Then go for another double?

    Just wondering

    BTW: The Trade Journal is great. Much easier to keep track of positions, etc.

    Thanks,
    Jeff

    • Alan Ellman July 16, 2022 6:09 am #

      Jeff,

      Let’s break this down. We have specific guidelines for all aspects of these scenarios.

      There are 2 reasons the value of our premiums will decline to 50% of the original sale price early in a contract outside of normal time-value erosion (Theta). In both cases, we are giving up 50% of our original initial time-value profit.

      1. The value of the underlying security declines as Delta drives down the premium value. Will taking a 50% profit (losing 50% of the initial profit, stated differently) enhance our portfolio by using a different security after closing both legs of the covered call trade? Since Theta has eroded the time-value of the premiums for the same contract expiration, we could do so using a security of greater implied volatility. In the BCI methodology, we would close the original trade if the original security was significantly under-performing the S&P 500, or if it meets our 7% threshold. Otherwise, no action is needed at that time as we continue to monitor our trades.

      2. The value of the underlying goes up in value, increasing the intrinsic-value component of the premium, but driving down the time-value component of the premium that may reach 50% of its original value. At this point in time, we have an unrealized maximum return with downside protection (of that time-value profit) equal to the intrinsic-value component of the premium. The BCI guideline is to close both legs of the trade, if we can generate at least 1% more than the time-value cost-to-close by contract expiration. This is known as the “mid-contract unwind” exit strategy in the BCI community.

      Bottom line: Closing our covered call trades when the time-value component of the premiums reaches 50% of the original value is not automatic but there are scenarios when such action is indicated.

      Thank you for the positive feedback on the TMC.

      Alan

  2. Barry B July 16, 2022 10:07 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 07/15/22.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them on The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:

    http://www.youtube.com/user/BlueCollarInvestor

    Best,

    Barry and The Blue Collar Investor Team
    [email protected]

  3. Alan Ellman July 17, 2022 6:40 am #

    Premium members,

    This week’s stock report was published a few hours ago and, on the surface, it appears challenging to populate our August contract portfolios. All eligible stocks fall into the “yellow” cells indicating earnings reports during the August contracts. I am writing this email to you to provide ideas as how we can circumnavigate these earnings season scenarios:

    1. The August contracts are 5-weeks in length, not the more typical 4-weeks. We can enter our August contract trades incrementally, some this week and some using next week’s premium member stock report and still generate our initial time-value return goal range for monthly contracts.

    2. We can select from the robust list of eligible ETFs in our most recent ETF report.

    3. We can write weekly options on the stocks in the report that show a “Y” in the “Wkly Avail” column and simply avoid the week of the ER.

    4. We can use the Blue Chip report of best-performing Dow 30 stocks all of which have weekly options and avoid the week of the ER.

    Bottom line: Earnings season is always challenging but we always have answers that will allow us to continue to follow the rules and guidelines that allow us to avoid unnecessary risk.

    Alan, Barry & the BCI team

  4. Don July 18, 2022 10:43 am #

    Alan,

    I need some help entering a rolling out and down put trade with QQQ:

    – On 7/11/22 I sold CSP on QQQ, strike of $283, expiring on 7/13 for $1.22 (QQQ at 290)
    – On 7/13 I bought to close the $283 strike expiring that day for $1.50 (QQQ at 285)
    – Also on 7/13, after the BTC, I sold a CSP on QQQ with a strike of $280 with an expiration date of 7/15 for $2.32

    This seems, to me, like I rolled down and out and I only see “Roll-Down/Sell Stock” or “Roll-Out-And-Up”. But maybe I just don’t understand the names. How would I enter this information?

    Thanks,
    Don

    • Alan Ellman July 18, 2022 3:35 pm #

      Don,

      Since the series of trades has 2 different expiration dates, here is the best way to enter and archive the trades, the 2nd of which is unrealized regarding final outcome:

      On the screenshot below (top-to-bottom):

      1. Enter the initial trade as shown in your comment
      2. On 7/13, when rolling out-and-down, exit the put with an initial and final return of 0.43%, 52.68% annualized.
      3. The adjustment section for the initial trade only shows the date of closure and the current value of QQQ. Yes, the put is still OTM but we can use the ITM exit strategy from the dropdown since we usually do not roll-out an OTM strike. A note to this effect can be entered in the Trade Management Journal on the far right (example: “Rolled-out an OTM put”).
      4. The final return for the 1st trade is the same as the initial return as the trade was originally structured.
      5. The rolling-out aspect of the trade is entered as a separate trade either on the same spreadsheet or a new one dedicated to the new expiration date (how I do it). This is shown as the 2nd trade at the top of the screenshot.
      6. Note that the put premium for the rolled-out trade is the net credit from closing the 1st trade and opening the 2nd ($2.32 – $1.50 = $0.82).

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

      Alan

  5. Alan Ellman July 20, 2022 5:07 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.

    New members check out our ongoing and never-ending training videos (“Ask Alan” and Blue Hour webinars). We add at least one new video each month. Only premium members have access to the entire library of these training tools.

    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

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