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JabberStokky, thanks for bringing this interesting book to my attention. There is a multitude of things you can do with options, writing covered calls is just one of them but arguably it's the least risky way of trading options. There are two ways to approach writing covered calls, as a sideline to a regular investment portfolio to generate additional income or as the feature attraction of the portfolio. I started trading options as a sideline selling both calls and puts (Dec 2008). Puts turned out to be too risky so I stopped trading them. As I improved my Covered Call Selector it became the feature attraction of my portfolio (May 2019).

I'm very much in tune with Alan Ellman's methods and I picked up some pointers from his book but I find him still too complicated. It has to do with putting your trust on price. Markets are information systems and the information about the value of goods and services is transmitted via prices. If the quality is good, the price goes up. If there is an abundance of the product, the price goes down. If there is a cheaper or better substitute the price goes down while the substitute's price goes up. It's an absolute marvel! Yet price has acquired a bad reputation based on clueless but pithy sayings such as Oscar Wilde's "A cynic is a man who knows the price of everything and the value of nothing." Here at the Fool The BMW Method was sharply criticized by people who don't understand the value of prices. We all understand intrinsic value but no one is capable of calculating it. I've searched the Investor's Bible, a.k.a. Graham and Dodd's Security Analysis and The Intelligent Investor for the magic formula and it's nowhere to be found. But price is everywhere and it determines whether a trade happens or not.

Why the above digression? Because the lack of faith in price leads people to search for intrinsic value in complex ways, expert opinion, fundamental analysis, Fed meetings, POTUS tweets, the list is endless. But it's all already priced into the PRICE! Of course price is not the only thing you look at but these other views are mostly of a binary nature, trade/don't trade. They determine whether we are willing to accept the price. Our decision creates a feedback loop that affects the price. That's how we all vote to create the PRICE! The magic of markets, the world's oldest information system.

Alan Ellman's downside is that he is still looking for intrinsic value. My breakthrough was finding or inventing "dollars per day." I very much agree with Ellman's casino model. The seller of covered calls is playing house while the buyer is the gambler. The object of the house is to set a vigorish that guarantees that over the long run the house is profitable. There is a risk of going broke if the individual bets are too large which is the reason for house limits. Selling covered calls you control that limit.* The above explain why covered calls are a low risk proposition.

An interesting point made by Ellman is that a stock is nothing but an amount of money and holding on to it (anchoring) is not going to increase it or bring it back. Holding on to it just decreases the capital available to create trades. The logical conclusion is that any stock that is not worth writing a call on should be sold NOW!

One insight that I picked up from Ellman is that the best calls are at-the-money or in-the-money (thanks JabberStokky!). The premium is yours to keep but the price of the stock at expiration is uncertain. Your safest trades would all be assigned, you keep your premium and free the money for the next trade. At-the-money and in-the-money premiums are higher than out-of-the-money premiums providing more profit or protection in case of falling stocks. Depending on the stock and on market bull/bear sentiment one can choose on which side of at-the-money you want to be.

Ellman does not seem to have a Call Selector which is central to my covered call trading. One wants to sell the best calls, but how to find them? Calls are not easy to compare, there are a number of variables such as stock price, time to expiration, strike price, and premium to consider. My unifying metric is "dollars per day." Upload fifty to sixty option chains of preselected stocks and that's about 30,000 possible options. By adjusting various parameters the Call Selector whittles them down to a manageable number which one can then fine tune. BTW, last week's selection is useless today. Because expiration dates and strike prices are not continuous but discrete and variable increments the Call Selector has to be run before the market opens with enough time left over for the fine tuning. Even so, once the market opens, premiums jump up and down.

To conclude, I need to tweak the Call Selector with what I learned from Alan Ellman.

Denny Schlesinger


* The Kelly Criterion

Using the Kelly Criterion for Asset Allocation and Money Management

https://www.investopedia.com/articles/trading/04/091504.asp
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Do you plan on selling ITM or ATM calls?

Selling too far ITM doesn’t seem to make much sense as the time value will be reduced. Selling IV without much TV doesn’t seem to make much sense.

AJ
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Do you plan on selling ITM or ATM calls?

Selling too far ITM doesn’t seem to make much sense as the time value will be reduced. Selling IV without much TV doesn’t seem to make much sense.


I had the same impression when I started out but Ellman has me reconsidering. I don't know yet but your questions points out one of the problems of looking at fundamentals instead of at results. Ellman bases his picks on a range of percent returns, if he gets that return in-the-money, go for it

Methodology

Option chains were evaluated for strike selections based on bear market environments (in-the-money strikes), neutral to bull market environments (out-of-the-money strikes) and a third portfolio where the average returns meet our goals. The stated goals for this analysis are 2% – 4% initial time value returns with upside potential or downside protection depending on overall market assessment and chart technicals.


[2% – 4% in 30 days is an example I found but I'm not sure of what his range is]

https://www.thebluecollarinvestor.com/establishing-our-optio...

In my case it would depend on "$ per day." The current version of the Call Selector eliminates in-the-money calls.

Denny Schlesinger
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Hi Denny, I'm very happy you're enjoying this book. I've found it to be a fun read, and I definitely learned some interesting strategy possibilities.

I spent yesterday evening doing some math with covered calls (because clearly that's the perfect Friday night activity). I've been using Excel to play with some scenarios. And in a way I like it - doing things manually lets me play around with some of the numbers to see what I'm getting.

And what I found is, indeed: the best ROO (return on options) is from calls that are at the money or very closely in the money. Not too bad (ROO) at very slightly out of the money calls either, you get upside opportunity but no downside protection - so end of day depends how bullish/aggressive you are. (a whole different topic I've got a lot of thoughts on! perhaps I'll write about this on Monday - I need to not be stuck at my computer on a beautiful Saturday ;) ) And of course as Ellman says, ITM have higher deltas vs OTM, so unwind scenarios (if required) are easier too.

Another thing I found, the best ROO (whether just return on options or even including upside potential) comes from calls with expiry close. That means, weeklies are more profitable than monthlies - have you found this to be the case? It makes sense logically (thinking about IV) but I've only looked at a few scenarios, my math isn't comprehensive. But I'm at the point where I think, if a stock doesn't have weeklies, I may as well ignore it.
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I spent yesterday evening doing some math with covered calls (because clearly that's the perfect Friday night activity). I've been using Excel to play with some scenarios. And in a way I like it - doing things manually lets me play around with some of the numbers to see what I'm getting.

Spreadsheets are amazing tools! Very often spreadsheet exercises have shown my intuition to be wrong. Most of my math with php is first checked with spreadsheets. I even used them to model the data flow of my current OOP php framework. They make it possible to visualize complex relationships. The most important piece of software on my very first personal computer, an Apple II, was VisiCalc, the grandaddy of spreadsheets. It was terrific for modeling the complex health insurance policies I was selling.

http://www.bricklin.com/visicalc.htm


And what I found is, indeed: the best ROO (return on options) is from calls that are at the money or very closely in the money. Not too bad (ROO) at very slightly out of the money calls either, you get upside opportunity but no downside protection - so end of day depends how bullish/aggressive you are.

On stocks that that exhibit zero growth the best options are at-the-money. On growth stocks out-of-the-money options are better because you also capture part of the growth. On declining stocks in-the-money options would be best. But I insist this is the wrong way to pick options because growth rate is just one variable in a very complex interplay of growth, time to expiration, strike price, volatility, market sentiment, news, and what not. $ per day (similar to ROO) picks the best calls to sell.

Suppose there are two $150 stocks one of which has calls that yield $40 per day and the other has calls that yield $35, which one would you trade? The one correction I make is setting a minimum dollar amount on the premium to avoid day trading.


Another thing I found, the best ROO (whether just return on options or even including upside potential) comes from calls with expiry close. That means, weeklies are more profitable than monthlies - have you found this to be the case?

Yes.

It makes sense logically (thinking about IV) but I've only looked at a few scenarios, my math isn't comprehensive. But I'm at the point where I think, if a stock doesn't have weeklies, I may as well ignore it.

Wrong! If you are a week away from expiration you have found a weekly whether the stock has weeklies or not!!! As above, find the stock that yields the highest $$$ per day. In my last run two were 8 days to expiration and the other two were 15 days to expiration. As above, time to expiration is just one variable in a very complex interplay...

Enjoy your Saturday in the Sun. Isn't it Winter in AussieLand?

Denny Schlesinger
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If you are a week away from expiration you have found a weekly whether the stock has weeklies or not!!! As above, find the stock that yields the highest $$$ per day. In my last run two were 8 days to expiration and the other two were 15 days to expiration.
I was sitting around thinking about options on Saturday and came to this realization before I read your post! And, I realized I was looking at options just after expiration Friday, which probably had an impact too. Gah, I just wanted to be lazy and whittle down my list of stocks but I suppose I'll have to do an actual three more minutes of work.

On growth stocks out-of-the-money options are better because you also capture part of the growth.
Yes, this is true. It boils down to how bullish you are on the stock.

Enjoy your Saturday in the Sun. Isn't it Winter in AussieLand?
Thank you. Yes, it's winter. It's been cold and miserable and gray but since Saturday the weather's been nice. The weekend was good. Fingers crossed spring is on the way.
I know it's summer on your side of the world - does it get humid in Portugal? I don't mind heat but can't stand humidity!
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I've only been in Portugal a little over three months so I'm no expert but there seems to be quite a difference between the cooler and wetter north and the hotter and dryer south. This Summer has been much cooler than normal.

Denny Schlesinger
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