Why not sell both covered calls and cash-secured puts on the same stock? I’ve been asked this question numerous times. There is actually a strategy that incorporates both BCI go-to strategies into one overall game plan. It is known as the covered strangle.
Components of the covered strangle
- Buy stock
- Sell call option
- Sell put option
The top two components represent the covered call aspect and the last is where we sell the cash-secured put.
We are looking to generate monthly cash flow while at the same time positioning ourselves to buy a stock at a “discount” should the share price expire below the put strike. Inherent in this plan is that we are willing to own twice as many shares as we currently own even if share price moves below the put strike.
Obligations (assuming no exit strategy intervention)
- Sell stock if share price moves above the call strike
- Buy stock if share price moves below the put strike
The risk is to the downside only. If there is price decline below the put strike, we double our position with half purchased initially and the other half at the put strike. Share price can move to zero. Of course, we always have our exit strategy arsenal to mitigate losing positions.
Strike price selections
We start by determining our 1-month (or other time frame) time value return goals, in my case it’s 2% – 4%. We use the Ellman Calculator to determine which strikes will fall into this range. We then fine tune our selections with these guidelines:
- The more bullish we are, the deeper out-of-the-money calls and closer to-the-money puts are selected
- The less bullish we are, the closer to-the-money calls and deeper out-of-the-money puts are chosen
All strikes must offer our initial time value return goals.
Real-life example with Applied Materials (NASDAQ: AMAT)
The yellow fields in this option chain highlight the out-of-the-money $57.00 call (with AMAT trading at $56.69) and the out-of-the-money $55.00 put. The bid prices (circled in red) are $1.90 and $1.36 respectively.
The formula to determine maximum profit: Call premium + Put premium + share appreciation to the call strike
The cost basis is the mid-point between the cost of shares initially purchased and the (put strike – put premium).
Let’s calculate per-share:
[($1.90 + $1.36) + $0.31]/[$56.69 + ($55.00 – $1.36)]/2
$3.57/$55.17 = 6.47%
For those investors looking to generate monthly cash flow while at the same time positioning to buy that same stock “at a discount” and doubling our position size, the covered strangle may be an appropriate strategy to initiate.
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1.Las Vegas Money Show
May 14th @ 12:30 – 1:30
2. American Association of Individual Investors: Charlotte NC Chapter
Saturday June 9th 9 AM – 12 PM
“How to Generate Monthly Cash Flow and Buy a Stock at a Discount Using Two Low-Risk Option Strategies”
This week’s economic news of importance:
- Consumer credit march $12 billion ($14 billion last)
- Job openings March 6.6 million (6.1 million last)
- Producer price index April 0.1% (0.3% expected)
- Weekly jobless claims for week ending 5/5/18 211,000 (215,000 expected)
- Consumer price index April 0.2% (0.3% expected)
- Federal budget April $214 billion ($182 billion last)
- Consumer sentiment May 98.8 (98.7 expected)
THE WEEK AHEAD
Mon May 14th
Tue May 1th
- Retail sales April
- Home builders’ index May
- Business inventories March
Wed May 16th
- Housing starts April
- Building permits April
- Industrial production April
Thu May 17th
- Weekly jobless claims through 5/12
- Philly Fed index May
- Leading economic indicators April
Fri May 18th
For the week, the S&P 500 moved up by 2.41% for a year-to-date return of 2.02%
IBD: Confirmed uptrend
GMI: 6/6- Buy signal since market close of April 18, 2018
BCI: Selling an equal number of in-the-money and out-of-the-money for new positions. The VIX has settled into a bullish range.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
The 6-month charts point to a slightly bullish tone. In the past six months, the S&P 500 was up 5% while the VIX (12.65) moved up by 10%. The volatility trend as well as economic news and corporate earnings bode well for profit opportunities.
Wishing you much success,
Alan and the BCI team