The 21s Are you tired of writing covered calls onty to see your stock ger called away as it heads into the stratosphere? Here is a strategy that professional traders use to kill two birds with ‘one option. by Robert J. Seifert hen I began trading options in 1983, one of the hardest trades to execute was to buy a put to protect against the downside risk inherent inthe ‘market. The problem with buying puts then and ‘now isthat the price you pay for the protection is B high and it's very hard to overcome the premium Joss. An alternative trade was to sella covered call for each quarterly expiration. Unfortunately, although this offers some protection, it can create a problem in markets that are in a Jong-term congestion phase Back then,executingacovered cal trade was done by selling a call every quarter against an underlying stock you owned. ‘When the option contract expired, you kept the premium you received when you sold the call, no matter what. Ifthe stock closed above the naked call’s strike price, you would keep the credit, but the stock would be called away from you (exercised). Your upside was limited to the credit while you ‘8+ Mach 2019+ Tonal Anabulof STOCKS & COMMODITIES Weeklys To The Rescue Century Covered Call hhad unlimited downside risk. Ifthe stock closed lower than the naked leg strike price but above your cost for the underlying stock, you would have kept the premium, which lowered your average cost forthe stock. ‘The problem with this strategy was that when the stock moved against you by more than the credit amount, you were left with unlimited downside risk. Trying to get out ofthis situation usually resulted in selling lower strikes, which ended With the stock getting called away ata loss. ‘As time moved on, the powers that be decided that if quar- terly options were good then perhaps monthly options might even be better so they added monthly options to the mix. You could write the same call 12 times a year. The advantage of ‘writing the call 12 times a year was tht it gave you more downside protection. However, it also gave you four times as ruc risk in thatthe premium inthe call you sold may not be enough to cover an advance inthe stock price and you could then lose the underlying stock. ‘Around 2010, the SEC decided that if monthly options were 00d, options that expired each week would be great! They started a pilot program using weekly options, which is now the biggest option product in the world. So if selling covered calls four times a year was a good deal, it must be a much better proposition to write them 52 times a year, right? Theanswer isa resounding yes. Over the years, this strategy has evolved and allows traders and investors amuch better chance to make money. No approach offers more opportunity than ‘what I call the “2ist-century covered call.” Let’s look at how this strategy works, First, we must address the number-one problem of writing covered calls: losing the upside potential if the stock takes off. To counter this situation, Isell a weekly call-credit spread instead of simply selling a call. To see how this strategy sets up, let's look at the option chain in Figure 1 for Tesla Motor Co. (TSLA) when the stock closed at $320.87. With TSLA at $320.87, the at-the-money (ATM) call is the 320.0 and itis trading at approximately $11.60. We want to use the ATM strike as the short call leg of the spread since it ‘gives you the most premium. Under the old method of selling covered calls, you would buy the stock at $320.87 and sell the 320.0 call for $11.60. Ifthe stock settled above $320, you would lose the stock at $320 but would keep the $11.60 credit, fora net gain of $10.73 ($11.60 credit - $0.87 stock loss). Not a bad deal, but if the stock went on to $360, you would miss ‘out on any profit past $10.73, Meanwhile, under the 2ist-century covered-call strateg} you would buy the stock at $320.87, sell the 320.0 call at 5311.60 and bay another eall at a higher stcike price with the same expiration date. You can buy any strike price you like but I recommend you buy one that is no more than $15.00 higher than the ATM, which in this ease would be the 335.0 call (ATM +6) So you would buy the stock at $320.87 and initiate a 320.0— 335.0 call-credit spread by selling the 320.0 call for $11.60 and buying the 335.0 call for $5.70, resulting in a net credit of $5.90 ($11.60 - $5.70). IF the stock settles above $325.90 (6320.00 + $5.90), le’s say $335.00, the call spreadwould bea $9.10 Taser since you wouldbe called away at $320.00 but you would exercise your 33500 call for a spread loss of $15.00 less the $5.90 credit. However, the stock por- tion of the trade would make $14.13 ($335.00 - '$320.87),s0 you would net $5.03 ($14.13 stock ‘gain-$9.10 spread loss) for the trade. So while your gain is $5.70 less than what you would have made the old- fashioned way ($10.73 = $5.03), you get a nice 10+ Mash 2019+ Thence Anais of STOCKS & COMMODITIES forri FIGURE 1: OPTION CHAIN OF WEEKLYS. Soo what te athe TONS | return and you still own the stock. ‘What about the downside? If Tesla’s stock were to close lower for the week, you would keep the $5.90 spread credit, which would limit your stock loss for the week. The good news is that no matter what happens, if you write the 2ist- century covered call for around a $5.90 credit 52 times a year, it would give you $306.80 ($5.90 x 52= $306.80) of ‘downside protection, which is 95.6% of the purchase price of the stock ($320.87). Ideally, you want to do this covered-call strategy with stocks thathaveagood chance of trading higherovertheneartermand thatalso have liquid, weekly options. To select stocks that meet this criteria, you can use a scanner similar tothe one we offer at MarketEdge (www.marketedge.com, a website developed by Computrade Systems, Inc, which has been in existence as either a software application or website since 1992). ‘There are six scenarios you can expect each ‘week when employing this strategy: lat,small Sei cin, rally, big rally, small loss, and big loss. AIAG Using TSLA as an example, ls check out Id the possible outcomes. Say you purchase 100 shares of TSLA at $920 and initiate the 320-335 call credit spread for $5.90. For illustrative purposes, the following as- sumes the option postions are closedon the weekly expiration date and the stock position remains open. Each week there will be a realized gain or loss in your option secount and an unrealized gain or loss in your stock account. Initial postion: 100 shares (TSLA) @ $320 = $32,000 Options: 320-335 call credit spread @$5,90 = $590 credit clare ag or and then se up your trading satey.1) Flat: The stock settles unchanged at $320 ‘This is a no-brainer. You pocket the $590 from the call credit spread. You have no change in your stock value. ‘Continue the next week by initiating another 320.0-335.0 call credit spread for a credit of around $5.90. ‘Total account value: $32,000 + $590 = $32,590 (6590 gain) 2) Small gain: The stock rises by about 1.5% to $325 ‘You pocket the $590 from the call credit spread on Monday, buy back the expiring in-the-money (ITM) shortcallat$5000n Friday afternoon (before expiration forarealized gain of $90 cn the options, an unrealized gain of $500 on the stock. Continue the next week by initiating a 325.0-340.0 call credit spread for a credit of around $5.90. ‘Total account value: $32,500 + $590 - $500 = $32,590 (6590 gain) 3) Rally: The stock rallies by about 5% ($15) to $335 ‘You pocket the $590 from the call credit spread on Monday, and buy back the expiring in-the-money spread at $1,500 on Friday afternoon (before expiration) for arealizedloss of $910 ‘on the options, an unrealized gain of $1,500 on the stock and. You want to do this covered- call strategy with stocks that have a good chance of trading higher over the near term and also have liquid, weekly options. Continue the next week by initiating another 335.0-350.0 call credit spread for a credit of around $5.90. Total account value: $33,500 + $590 - $1,500 = $32,590 ($550 gain) 4) Big rally: The stock rallies by about 9% to $350 ‘You pocket the $590 from the call credit spread on Monday, ‘and buy back the expiring in-the-money spread at $1,500 on Friday afternoon (before expiration) fora realized oss of$910 ‘on the options, an unrealized gain of $3,000 on the stock and 5you keep the stock. Contin om poge 33 ABLETREND 7.0 Time-tested Trade Signals m™ ABLESYS 15-218 herd Worn Tat Sat Sock ats ret Sas Buy on Blue fet aK nage ms efit Qi ee Xx HX xxx No Trade Zone Conflicting Color Filters out High Risk Test-drive it to See All the Signals! www.ablesys.com/SCM blesys Comp - 20854 4 Low Risk& High ee wt ike No Trade yy aoe ~ Zone — Timely Protection Warning Signals $40 Discount code: SCMF19 &, 510-265-1883 [© sales@ablesys.com March 2019+ Tecnico Anayicof STOCKS & COMMODITIES» 11