By blue chips and dips, we’re not talking about those fancy blue corn tortilla chips with salsa, no we’re talking about Covered Call positions for stocks of blue chip companies or very large companies.
Most Well Known Stock Option Strategy
The Covered Call strategy is the most well known stock option investing strategy. The Covered Call strategy is easy to implement and is less risky than many other stock option strategies. Entering a Covered Call position entails purchasing a stock and selling a call option against the purchased stock. The Covered Call position can return a higher return than experienced by the plain-old long stock position, and the converse is also true, the long stock position can return a higher return than the Covered Call position. A typical potential return for a Covered Call position is around 2-3% over a timeframe of one month.
Managed vs. Unmanaged
The Covered Call position is commonly referred to as having limited upside, which is true for an unmanaged Covered Call position, but for a managed Covered Call position, the upside is not limited, as the position can be continually rolled for realizing increased return.
The Covered Call position has a nice characteristic in that it has downside protection, i.e. the long stock for the position can decrease in price, however, the Covered Call position can still return a profit.
Another twist for the Covered Call strategy is legging-into a position. For this scenario, the long stock is purchased and the call option is sold against the stock at a later date following an increase in the price of the stock. Typically, the legged-in call option is sold at-the-money. At-the-money refers to the price of the stock and the strike price of the option at approximately the same price. For example, a stock could be purchased at $50 and when the price of the stock reached $55, a call option with a $55 strike could then be sold against the stock. Legging-in allows an investor to participate in the appreciation in the price of the stock and also generate income from selling options against the stock.
A similar strategy to legging-in is entering an out-of-the-money Covered Call position. For an out-of-the-money Covered Call, the call option is sold simultaneously to the purchase of the stock, but the strike price of the call option is greater in price than the underlying stock price. An out-of-the-money Covered Call enables an investor to realize profit for the increase in the price of the stock and also for income from selling call options against the stock. In comparison, the income generated from the option for the out-of-the-money Covered Call is less than the income generated from legging-into an at-the-money Covered Call.
A Collar strategy takes the Covered Call method step further with the purchase of a put option for protection or insurance. A put option can be thought of as insurance for stocks, if a stock drops in price, the put option can insure against a large loss. The problem with a collar strategy is the put options are generally very expensive and eat into the potential income for a Covered Call. Whereas a Covered Call position may have a potential return of 2-3%, a Collar on the other hand may have a potential return of 1%-2%. Even after purchasing the protective put option, a Collar position can potentially sustain a double-digit percentage loss.
Covered Call on the Dips
Entering a Covered Call on the dips for blue chip companies can act to mimic a Collar position without having to pay for the protective put option. The idea is to enter a Covered Call or purchase a blue-chip stock with the intent of legging-into a Covered Call at a point in time where the price of the blue-chip stock has “dipped”. The position is not protected by a put option, but at some point potential buyers of a blue-chip stock will step up and purchase the stock thereby putting a bottom under the stock. An added bonus is to enter a position for a blue-chip stock paying a nice dividend, as potential buyers are more prone to step up and purchase a dividend stock when the dividend yield becomes attractive, i.e. the lower the stock price goes, the higher the dividend yield realized and the more prone an investor is to purchase the stock for the dividiends.
As an example, we will consider a Covered Call position for Kohl’s (KSS) entered for the PowerOptionsApplied Titanium TradeFolioTM on 1/10/2011. Titanium publishes Covered Call positions for blue-chip (very large) companies, which have taken a “dip”. At the time of entry, Kohl’s did not pay a dividend, but in the month of February following entry of the Covered Call position, Kohl’s announced they would pay a dividend.
The stock chart for KSS at entry on 1/10/2011 is shown below:
As can be seen from the stock chart for KSS, the price of KSS was near the 200-day moving average, near the lower Bollinger band and also near the previous support level for the stock occurring in November of 2011. The lower Bollinger band can be a good indicator for the recovery of a stock, as a stock will often recover after touching, crossing or coming near the lower Bollinger band. Previous support level is a good indication of where investors were willing to step up and purchase a stock during its last dip and is a good indicator that investors may be willing to once again step up and purchase the stock around the same price point.
At entry, the price of KSS was $52.03 and the option sold was a KSS 2011 FEB 52.50 call option at a price of $1.37.
A profit/loss chart for the initial KSS Covered Call position is shown below:
At entry, the unchanged potential return for the position was 2.7% with an assigned potential return of 3.6%. Unchanged potential represents the return a position would realize at options expiration if the price of the stock were unchanged from the price at entry. Assigned potential return represents the return a position would realize at options expiration if the price of the stock were greater than the strike price of the call option.
On 2/17/2011, the time value for the KSS 2011 FEB 52.50 call option was very small, so the KSS 2011 FEB 52.50 was rolled to a KSS 2011 MAR 52.50 call option for a net credit of $0.90. Time value represents the difference between an option’s value and its intrinsic value. For Covered Call investing, time value can be used as a gauge for the remaining potential profit available for a position.
The total net credit received for KSS was $1.37+$0.90 or $2.27 with a resulting assigned potential return of 5.4%.
On 3/18/2011 at March option expiration, the price of KSS was at $52.77, so the KSS 2011 MAR 52.50 call option was exercised with the KSS stock being called away from the account. As a bonus, KSS paid a dividend of $0.25 per share on 3/7/2011. The realized return for the KSS Covered Call including the dividend was 5.9%. An investor simply purchasing a long position in KSS and receiving the dividend would have realized a return of 1.9%. The comparison for the Covered Call versus a long stock position is shown below:
The Covered Call position had another advantage over the long stock, as the Covered Call position had downside protection, so as long as KSS did not drop more than the initial net credit of $1.37, the Covered Call position would have realized a profit.
The return for the PowerOptionsApplied Titanium TradeFolioTM over the last year employing Covered Calls for blue chips on the dips realized a whopping return of 25% which is very good considering the S&P 500 had a return of about 15% over the same time period.
The Titanium TradeFolioTM publishes Covered Call positions for blue-chip (or very large) companies, which have taken a dip. Titanium had a success rate of 90% over the last year with many of Titanium’s positions paying a dividend. The positions for Titanium are continually monitored for news which might have a negative impact. For example, some of Titanium’s losing positions were exited early as a result of bad news associated with the company. Particularly, during the oil spill in the Gulf of Mexico and the tsunami/nuclear disaster in Japan positions were exited early. In each case of exiting a position for a loss, the loss for the Covered Call position was less than for a long position in the stock, as the Covered Call positions had downside protection.
Titanium offers a diversified portfolio of Covered Call positions, typically twenty positions open at any given time. Titanium adds two-to-eight new potentially profitable positions every month.
As an added bonus, subscribers to Titanium can add “insurance” with the “Safety Net”. Safety Net purchases VIX call options for insurance, as the VIX moves counter to the movement of the stock market. So, as the stock market drops, the VIX and its call options increase in price. Insuring with VIX call options can protect a portfolio cheaper than using index put options, for example.
Titanium also offers auto-trading with select brokers so investors don’t have to enter or manage the published trades, everything is automatically handled by the broker.
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|I looked at your reported performance for Titanium and Palladium. I put 406,000 in about Feb of 2010 at OX and signed up for Xecute. Today I have 457,000 and I took 20K out… It seems like you are not tooting your own horn loud enough…
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