Why should we spend the time to educate ourselves on how to implement and manage covered call writing trades? The answer is simple: Once the 3 required skills (stock selection, option selection and position management) are mastered, we will put ourselves in a position to beat the market on a consistent basis. This article will break down the reasons why this great strategy allows us to accomplish investment returns that most mutual funds are incapable of achieving.
When we buy a stock and then sell a corresponding call option, we are lowering our cost basis. For example, if we buy stock BCI at $33.00 and sell the $35.00 1-month call option for $1.50, our cost basis is reduced from $33.00 to $31.50. Who has a better chance of success; an investor with a cost basis of $31.50 or one with a cost basis of $33.00 (a rhetorical question). This is the main philosophical reason we write covered calls and are willing to cap the upside… reducing our cost basis increases our chances for success.
Pool of stocks
The overall market (S&P 500 is generally the benchmark most investors employ) consists of securities that are performing at different levels…the good, the bad and the ugly. By establishing a portfolio of only elite-performers from fundamental, technical and common-sense perspectives, we are creating an environment to out-perform this benchmark.
Impact of market performance
The overall market will move up and down in the short-term and up in the long-term. Since covered call writing represents 1-month obligations (weekly obligations for some of our members), portfolios can be adjusted on a monthly basis to reflect the most appropriate investment decisions for that specific point in time.
Option selection based on market assessment
The option strike price will dictate premium (ROO) return, downside protection of the initial time value profit or upside potential when out-of-the-money strikers are sold. Every month, we can determine which strikes to select and therefore how much to reduce our cost basis versus allowing for higher share appreciation. This will give us an edge over the S&P 500 in that our portfolios can be tailored to mitigate losses and enhance gains on a monthly basis.
Avoiding risky events
Disappointing earnings releases are the main reasons for significant share decline. Our covered call portfolios always avoid earning report risk. Also, by calculating option returns, we can also avoid risky, highly volatile securities. I look to generate 2% – 4% per month for near-the-money strikes. I will consider returns as high as 6% in bull markets but no higher due to the risk in high volatility stocks.
Our covered call writing portfolios represent 2 positions: we are long the stock and short the option. All exit strategies begin by buying back the short call and thereby creating scenarios to re-sell options or sell the underlyings. When markets decline our portfolios can be managed to break-evens or even profits in many situations.
After mastering the 3-required skills, implementing covered call writing portfolios will allow us to beat the overall market on a consistent basis. The main reason for this success relates to the fact that the strategy lowers our cost basis but many other factors come into play.
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
New seminar just added
Charlotte North Carolina:
September 14, 2019
9:30 AM – 12 PM
Your generous testimonials (new feature)
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:
Really love your work Sir. I honestly think you are the best resource for covered call education, and you come across as a genuine, kind personality.
This Thanksgiving, I am thankful to have you on the internet.
Thanks and regards,
This week’s economic news of importance:
- ISM nonmanufacturing index Dec. 57.6% (58.7% expected)
- NFIB small-business index Dec. 104.4 (104.8 last)
- Job openings Nov. 6.9 million (7.1 million last)
- Consumer credit Nov. $22 billion ($25 billion last)
- FOMC minutes
- Weekly jobless claims 1/5/19 216,000 (227,000 expected)
- Consumer price index Dec. -0.1% (as expected)
THE WEEK AHEAD
Mon Jan. 14th
- None scheduled
Tue Jan. 15th
- Producer price index Dec.
- Empire state index Jan.
- Retail sales Dec.
- Import price tax Dec.
- Business inventories Nov.
- Home builders’ index Jan.
Thu Jan. 17th
- Weekly jobless claims 1/12
- Housing starts Dec.
- Building permits Dec.
- Philly Fed index Jan.
Fri Jan. 18th
- Industrial production Dec.
- Consumer sentiment index Jan.
For the week, the S&P 500 moved up 2.54% for a year-to-date return of 3.57%
IBD: Market in confirmed uptrend
GMI: 2/6- Bearish signal since market close of November 13th, 2018 as of Friday morning
BCI: With volatility settling, I am taking a more aggressive stance and favoring out-of-the-money strikes 3-to-2 compared to in-the-money strikes.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
The 6-month charts point to an improving market tone. In the past six months, the S&P 500 down 6% while the VIX (18.19) moved up by 33%, both improvements over last week.
Wishing you the best in investing,
Alan and the BCI team