Option selection is the second required skill when selling call and put options. On 9/26/2017, George shared with me a trade he executed with Biogen, Inc. (BIIB). An in-the-money strike was sold and share price immediately accelerated. George was inquiring about how deep in-the-money (ITM) the strike prices should be set.

• Buy 100 x BIIB at \$313.80
• Sell (1-month) \$307.50 call for \$8.20
• 9/26/2017: Stock trading at \$318.46

We use in-the-money strikes when concerned about potential price decline of the underlying security.

Calculating initial timer-value returns

BIIB: Initial Covered Call Writing Returns

Using the multiple tab of the Ellman Calculator, we see an initial time-value return of 0.6% with a downside protection (of that initial profit…not breakeven) of 2%. When evaluating if this was the best strike to select we must first define what the goals were prior to entering the trade. If the return goal and protection goals were met, then yes this was the appropriate strike. If not, a more relevant option should be considered.

One month later

With BIIB trading at \$328.78 on 10/23/2017, let’s view the option chain for in-the-money strikes and assume a goal of 2% – 4% for initial time value returns (my personal preference):

BIIB: Options Chain on 10/23/2017

We will evaluate three in-the-money strikes (\$315.00, \$317.50 and \$320.00) by entering the information into the multiple tab of the Ellman Calculator:

BIIB: Calculating In-The-Money Strikes

The initial time value returns of all 3 strike prices approximate our 2% – 4% 1-month goals. If we are looking to generate the most protection of the time value profit, we would favor the \$315.00 strike (4.2%). If we preferred the greatest time value profit, then the \$325.00 strike should be considered. The \$320.00 strike is an excellent compromise.

Discussion

When deciding on which in-the-money strike to select, initial time value goals must first be established. From there, the amount of profit protection should be considered. Once those two components are defined, strike selection will become apparent.

***Thanks to George for sharing this trade with us.

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Tuesday May 8th, 2018 7 PM -9 PM

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Market tone

This week’s economic news of importance:

• Retail sales march 0.6% (0.4% expected)
• Housing starts March 1.319 million (1.255 million expected)
• Building permits March 1.354 million (1.321 last)
• Weekly jobless claims 4/14 232,000 (230,000 expected)
• Leading economic indicators March 0.3% (0.7% last)

Mon April 23rd

• Markit manufacturing PMI April
Markit services PMI April
Existing home sales March

Tue April 24th

• Case-Shiller home prices Feb
• Consumer confidence index April
• New home sales March

Wed April 25th

Thu April 26th

• Weekly jobless claims through 4/21
• Durable goods orders March

Fri April 27th

• GDP Q1
• Consumer sentiment index April

For the week, the S&P 500 moved up by 0.52% for a year-to-date return of (-) 0.13%%

Summary

IBD: Market in confirmed uptrend

GMI: 6/6- Sell signal since market close of March 23, 2018

BCI: Selling 2 in-the-money strikes for every 1 out-of-the-money strike for all new positions. Earnings season should be a positive for the market.

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

The 6-month charts point to a bearish sentiment. In the past six months, the S&P 500 was up 2% while the VIX (16.79) moved up by 75%. The VIX has calmed a bit more from the prior week.

Wishing you much success,

Alan and the BCI team