Exit strategy preparation and implementation is one of the 3 required skills for successful covered call writing and put-selling. Because of the time value erosion of our options (Theta), there are limitations regarding the exit strategy opportunities as our contracts near expiration. In January 2018, Duminda contacted me about a trade he executed with Five Below, Inc. (NASDAQ: FIVE) that appeared to head south late in the contract month.

 

Duminda’s trade

  • 12/18/2017: Buy 100 x FIVE at $68.66
  • 12/18/2017: Sell 1 x $70.00 call at $2.25
  • 1/8/2018: FIVE gaps down to $65.00 on a downbeat profit forecast
  • 1/8/2018: The cost-to-close the $70.00 call is $0.80
  • 1/18/2018: Stock price is $66.96 (the day this article is being written)

 

FIVE gap-down in January 2018

covered call writing and technical analysis

FIVE Chart Showing Price Decline in January 2018

 

Exit strategy opportunities?

Buy-to-close the short call

Since we are in the second half of the January contracts, the 20%/10% guidelines for closing the short call points us to a buy-to-close price in the $0.23 area (10% of $2.25). The current cost–to-close is $0.80, well above that threshold.

Close the entire position if news is egregious or well-under-performing the S&P 500

Although negative earnings guidance can cause a temporary hit in share price, it can also be related to creating a softer landing when the actual earnings report is released. Also, the stock started to rebound shortly after the gap-down. The stock was slightly under-performing the S&P 500 when viewing a 1-month chart (+2% to +5%), also not enough of a discrepancy to make selling the stock an obvious path to take.

covered call writing and gap-downs

FIVE and S&P 500 Comparison Chart

Take no action

Given that the 20%/10% guidelines were not met, the stock price began to recover and the 1-month comparison chart with the S&P 500 was not strongly bearish, this is a reasonable path to consider.

 

Calculations

Initial time value return (ROO)

$2.25/$68.66 = 3.3%

Cost-to-close on 1/8/2018

$0.80/$68.66 = 1.2%

Trade results as of 1/18/2018 taking no action

$225.00 (option premium-per-contract) – $170.00 (current share value loss) = + $55.00 = 0.8% 1-month return = 9.6% annualized

 

Discussion

Position management implementation may not always be obvious. By adhering to a structured system that has its basis in sound fundamental, technical and common-sense principles, we will make the best choices in most circumstances. In this article, we used fundamental news, review of price charts, comparison charts and use of our 20%/10% guidelines to determine that sometimes the best action is no action at all.

Thanks to Duminda for sharing this trade with our BCI community.

 

New videos available

The BCI team recently uploaded 2 more videos to your member sites:

Blue Hour 10: How to Generate Monthly Cash Flow and Buy a Stock at a Discount Using 2 Low-Risk Option Strategies

Ask Alan #149: How to Structure Portfolio Strikes

 

Upcoming events

Denver Colorado: American Association of Individual Investors

August 18 @ 9:00 am – 12:00 pm

Saturday August 18, 2018

Click for information and registration details

 

San Francisco Money Show

August 23 @ 10:00 am – 11:00 am

Hilton San Francisco Union Square

1.Thursday August 23rd: 12:30 PM – 1:15 PM

All Stars of Options: “How to Select the Best Covered Call Options in Bull and Bear Markets”

2. Friday August 23rd: 10:15 AM – 1:15 PM

Masters Class: “How to Generate Monthly Cash Flow and Buy a Stock at a Discount Using 2 Low- Risk Option Strategies (covered call writing and selling cash-secured puts)”

3. Friday August 23rd: 6:00 PM – 6:45 PM

Workshop: “Converting Non-Dividend Stocks to Dividend Stocks using Stock Options”

Click for information

 

Market tone

This week’s economic news of importance:

  • Job openings June 6.7 million (6.7 million last)
  • Consumer credit June $10 billion ($24 billion last)
  • Weekly jobless claims 8/4 213,000 (217,000 expected)
  • Producer price index July Wholesale inventories June 0.0% (0.2% expected)
  • Consumer price index July 0.2% (as expected)
  • Core CPI July 0.2% (as expected)

THE WEEK AHEAD

Mon August 13th

  • Survey of consumer expectations July

Tue August 14th

  • NIFB small business index
  • Import price index

Wed August 15th

  • Retail sales July
  • Productivity Q2
  • Industrial production July
  • Home builders’ index August
  • Business inventories June

Thu August 16th

  • Weekly jobless claims 8/11
  • Housing starts July
  • Building permits July
  • Philly Fed Index August

Fri August 17th

  • Consumer sentiment Aug
  • Leading economic indicators July

For the week, the S&P 500 moved down by 0.2% for a year-to-date return of 5.97%

Summary

IBD: Market in confirmed uptrend

GMI: 6/6- Bullish signal since market close of July 9, 2018

BCI: Using an equal number of in-the-money and out-of-the-money strikes. Impact of foreign currency issues, tariffs/trade wars unclear.

 

WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US

The 6-month charts point to a bullish tone. In the past six months, the S&P 500 was up 6% while the VIX (13.16) down by 48%.

Wishing you much success,

Alan and the BCI team

 





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