Alan Ellman

Alan Ellman
Contributor since: 2011
Company: The Blue Collar Investor Corp - Investing with Stock Options
Your opinion is accepted with respect. Let me offer the following as food for thought:
1- The process: Use fundamental analysis, technical analysis and common sense principles to select the appropriate underlying securities. Then use overall market assessment and technical analysis for best srtrike price selection. Then execute the trade. Once a position is taken, it is monitored by a very specific 20/10% guidelines which will dicate if and when the option should be bought back. Future steps are based on chart technicals and market assessment.
2- A zero sum game...yes. Covered call writers are the sellers of a decaying asset. 80% of options expire worthless. Theta or time decay is on our side and share appreciation is also an opportunity covered call writers can share in by selling out-of-the-money strikes. We are the casino.
3- Finally, one possible definition of luck is: the intersection of preparation and opportunity. As I previously stated: There is no one strategy that is right for every investor. For those who have done their due-diligence and fully educated themselves about a certain strategy and then rejected it, you have my utmost repect. I'll leave it to others to continue this thread,.
My best to all
My name is Alan Ellman. Since Jay mentioned my name I thought I’d jump in here with a few thoughts. First of all, there is no one strategy that is right for every single investor. It may be right for me and Jay and not for others. That being said, let me reference a 16-year study on the CBOE site (Ibottson) where covered calls were sold against the S&P 500, using slightly out-of-the money call options and monthly expirations and then the results were compared to the overall market. The results showed that covered call writing slightly outperformed the overall market but with less volatility (lower standard deviations of price movement). So far, so good with covered call writing.
But, in my view, the study is flawed, or stated differently, could have been enhanced. In the eyes of this covered call writer, here is what the study did properly:
1- It favored 1-month call options
Here is where there is room to achieve higher returns:
1- Why sell calls on all stocks in the S&P 500? Why not select the ones with the best fundamentals and technicals?
2- Why select only out-of-the-money strikes? These are higher than current market value. In-the-money strikes are much more appropriate in bearish or volatile market conditions or when chart technicals are mixed and not all bullish signals.
3- Why is there no position management? Shares were bought, options sold and then the next step was after expiration. I’ve written an entire book on exit strategies for covered call writing. It will take your returns to much higher levels by being pro-active as I’m sure Jay knows.
The point here is that if covered call writing can slightly out-perform the market doing 75% of the maneuvers less than perfect, what can be expected if the system is mastered? This means not being pretty good at it, but mastering it (about 3 levels above pretty good).
If I’m not being too wordy in this venue, here are the disadvantages of covered call writing coming from an investor who has been using this strategy for two decades (written 3 books and lecture all over the country on the topic):
1- If the stock price drops below the breakeven (purchase price minus premium), you start to lose money (that’s where the exit strategies kick in).
2- ***(main disadvantage)- Your profit is limited by the strike price: If you buy a stock @ $48 and sell the $50 call and the stock price jumps to $60 in a week (FDA approval of a drug, stock split, dividend announcement etc.), you will realize a great return but not as much had you not written the call. This will occur infrequently, but it will occur. In covered call writing, we hit singles and doubles but not grand slam home runs.
3- Early assignment (your shares being sold) can occur early. This is no big deal to me but it is to many others (I’ve been in touch with thousands of covered call writers over the years so take my word on that one). 99.999% of the time assignment will occur the day after expiration Friday and can be avoided by rolling the option (buying it back and selling the next month option). A rare exception is when there is a dividend distribution and the dividend value is greater than the time value remaining on the option premium (sorry for getting a bit complicated here…just want to be complete).
4- There is a learning curve and time commitment to mastering this strategy. Once mastered, it becomes a non-factor.
To sum up: There is no strategy right for every investor. For those who master every aspect of the covered call writing strategy it can be quite rewarding. Another advantage is that our government considers this strategy appropriate for self-directed IRA accounts.
One last thought. I used to write articles on covered call writing for Seeking Alpha but they stopped permitting articles on options. I still write on my blog.
Excellent thread to one and all.
I do not personally use this product because I don't drink soda but I know others who do. A SodaStream machine kit comes with a cylinder already full. When empty, it is swapped for an exchange cylinder which sells at a suggested retail price of $14.99 for one 60 liter (25 cents per liter). Adding the cola mix of $4.99 (which makes 12 liters) is another 42 cents per liter. Total cost to make cola is 67 cents per liter or about 25 cents per can. I understand that you will not experience any flat, wasted soda, as you would with store-bought soda, due to the sealed cap. Also, no bottle or can deposits.
There is also the convenience of not lugging, storing or disposing of heavy, bulky cans and bottles. I wrote the article based on fundamentals and option returns but the product does appear impressive.
In my books and DVDs I explain that I use the more bullish exit strategies in the earlier part of the contract cycle and the more bearish ones (rolling down) in the latter part of the cycle. No way of predicting precisely but throwing the odds in our favoring and providing protection to mitigate losses.
You may want to consider my latest book as well, Alan Ellman's Encyclopedia for Covered Call Writing, which has over 70 pages relating to exit strategy execution + another 400 pages relating to all aspects of this strategy.
Covered call writing and selling cash-secured puts are quite similar. There are some nuances that make the strategies slightly different. For example, as a covered call writer and therefore the share holder, you capture corporate dividends, not the put seller. This may be partially offset by the fact that the puts may have more value than the calls in this situation. The most significant difference, in my view, is that as a cc writer, your choices regarding exit strategy execution are far greater and I've actually written an entire book on this one topic. You may want to close your short position and retain the long position and take advantage of the typical whipsaws a stock gyrates through each month. Finally, for reasons I can't explain many brokerages require a higher level of trading approval to sell cash-secured puts rather than covered calls and may not permit the sale of cc puts in self-directed IRA accounts. Overall, both are similar with the main caveat being exit strategy execution choices.
Early exercise of the option the day prior to the ex-dividend date is a concern if the time value of the premium is less than the actual dividend distribution. In this case you may want to roll the option to a later date.
Consider 20-d and 100-d exponential moving averages when selling 1-month options as opposed to longer term simple moving averages.
I have no problem with a stop-loss on the short position. As a matter of fact I have set up a 20/10% guideline in my books and DVDs for that very thing. However, in many situations also selling the underlying is NOT the best choice.
This was an example that I took from one of my books to highlight the importance of being prepared with an arsenal of exit strategy choices. It occurred in 2008 when everything was going down!
You do not know in advance how a stock will react. The main point here is that we need to be prepared for all possibilities. I have an exit strategy ready to go for many other situations as well as the one I highlighted in this article. So let's say that "luck" is the intersection of preparation and opportunity.
That is exactly spot on!
I use the VIX as ONE of my guides to determine my stance on my covered call positions. I do NOT sells calls on the VIX. For example, all other parameters being equal, a bearish (ascending, above 30) VIX will guide me to using in-the-money strikes, low beta stocks and favor certain ETFs. Please keep in mind this the VIX is one of several indicators I use in my investment decisions but it is an important one.
It is functional but you will need to scroll down and enter your email address first. Subscribing to the premium membership will give you a FREE version of the Elite version of the calculator with 7 additional tabs. Write me directly if you have a problem:
The spreadsheet is FREE:
Go to my web site and look for the link at the top of the page (black bar) titled "free resources" The Basic Ellman Calculator and its user guide can be downloaded for FREE.
We are in full agreement here..."duds" should be avoided. How we define a "dud" and how we screen them out is open to interpretation. Just turn on CNBC any day and watch the experts disagree with each other about every single stock they are discussing. Diversification and cash allocation is a step I strongly believe in only after screening thousands of equities and ETFs fundamentally, technically and adding in several common sense principles like avoiding earnings reports, among others. When the watch list is formulated (you see part of an older watch list in the above article) it contains stocks that are among the strongest fundamentally and technically AND in the top-performing industries. They have also passed the "common sense" screens inherent in the BCI methodology. Then, and only then, do we look at diversification and cash allocation. We may differ on the importance of diversification but absolutely agree on the avoidance of "duds".
Glad you liked the article and appreciate the feedback.
If diversification is the main goal then, why not just write calls on SPY to avoid all the calculations?
Diversification is not the main goal but rather the final step in the art and science of developing a covered call portfolio. The main goal is to create a monthly cash flow while highlighting the need for capital preservation.
As stated by mjs_28s, individual equities will generate higher returns than ETFs.
Absolutely. Check out this article I published on the blog link on my web site on May 26th:
Scroll down and enter your email address to gain access to the calculator. You will then see a "download" tab.
Check the top (black) bar on the site.
Thanks for the feedback and showing how confusing these scenarioscan be.
Yes, this is an article I took from my latest book. The numbers are not current but the concepts are.
Go to my website and look for the link "Free resources including the Ellman Calculator". It is located on the top bar of all pages.
The article was taken from a column I previously published on my web site. The general concepts of calculating covered call returns rather than recommending specific equities was the intention of this article.
Thanks for the generous comment. I will include such articles in the future. Many are already loctated on my web site but I'm happy to also share them with this wondeful community of investors.
Having an arsenal of exit strategies will elevate your profits exponentially. I've written an entire book on this topic. I will include articles relating to this subject on this site as well as my own. The important takeaway if that you MUST master exit strategy execution when using this strategy.
That is generally true UNLESS there are tax consequences associated with that assisgnment. Good point.
You raise a valid point. When using the covered call strategy especially favoring one month short positions as I do, it is IMPERITIVE to use an online discount broker. There are a number of reliable brokerages that will render commissions NEARLY a non-event especially if you trade multiple contracts per position . If you favor a full-service broker the returns will absolutely decline. One of the reasons I wrote three books on this subject was to assist average retail investors in MASTERING this strategy eliminating the need for full service brokers. Let me also point out that using full service brokers does make sense for many investors using other strategies. Thanks for making the point.
I concur that it is not good strategy to use the same stock month in and month out. I,too, avoid earnings reports. However, the cash invested in that stock can be used on a monthly basis, the underlying will change.
Selling 1-month covered calls represents most of my stock portfolio. I also dollar cost average into stock and bond index funds for longer term investing. I am a firm believer in asset allocation so my total portfolio is heavily invested in real estate, bonds and businesses. Thanks for your kind words.
Take a look at the risk of being in a covered call position when there is an earnings report scheduled prior to contract expiration. You may want to exit that stock every third month or enter your position after the report. I will address this in a future article.
If the time value of the premium (Premium minus intrinsic value) is less than the dividend to be distributed there is a chance of early exercise. To avoid this you should roll the option prior to the ex-dividend date. There is another way to view this: If the shares are sold (and tax issues are not a factor) you have maximized your covered call trade and now have cash back into your account. You can now use this cash to generate a second income stream in the SAME month with the SAME cash. I refer to this as the "mid-contract unwind" exit strategy in my latest book.