How To Select Replacement Stocks Mid-Contract
Dr. Alan Ellman | Feb 28, 2016 02:35AM ET
Exit strategy management for covered call writing and put-selling is one of the three required skills (stock selection and option selection are the other two) critical to maximizing our returns. A few of the position management opportunities require exiting a position related to a particular security and then locating a new stock to begin another option-selling trade. This article will highlight one way we may choose to use our Premium Stock Report to locate such a replacement stock. I am writing this hypothetical scenario on 12/2/2015 using the most recent Premium Stock Report dated 11/27/2015.
There are many ways to use our reports so keep in m ind that I am presenting just one possible screening process. In this case the investor prioritizes the stock selection as follows:
- Price per share
- Industry segment rank of “A”
- Scouter rating (currently available only from The Blue Collar Investor) of “9” or “10”
Premium Watch List from 11/27/2015 (partial list to fit this article)
Premium Watch List from 11/27/2015
There are two stocks that meet our initial screening requirements, O:ATVI and O:CSFL but note that CSFL does not have adequate option liquidity (“N” in second column from right). Next, let’s check to see our potential returns for the remaining twelve trading days in the December contracts:
ATVI Options Chain from 12/2/2015
Next, let’s feed this information into the multiple tab of the Ellman Calculator to see if any meet our 12-trading day goal:
Get The News You Want
Ellman Calculator returns for ATVI
We find that all four of the selected strikes offer significant initial returns for the remainder of the December contracts. The more bullish we are, the higher the strike we would favor and vice versa.
Discussion
Option-selling results are enhanced by being diligent regarding position management. Periodically, we will need to locate a replacement stock which will be aided with a high-quality watch list and a set of screening parameters as well as return goals. Once a system is established, the process becomes second nature to us and time efficient.
Market tone
Global markets moved up this week in conjunction with a rebound in the financials and energy sectors. The Chicago Board Options Exchange Volatility Index (VIX) fell to 19.5 from 27.5 last week. This weeks reports and other international news of import:
- Saudi oil minister Ali Ibrahim Al-Naimi said producers will meet in March in hopes of negotiating an output freeze
- Business confidence in Germany slipped in February, according to the closely watched Ifo business climate index. The index fell to 105.7 from 107.3 in January
- Several large US banks are increasing loan loss reserves in anticipation of more troubled loans to companies in the oil and gas industry
- US GDP during the fourth quarter of 2015 was revised upward to 1%, up from the 0.7% initial estimate, but still lower than the 2% pace set during the third quarter
- For the full year, gross domestic product rose 2.4%, matching 2014’s growth rate
- The Shanghai Composite Index dropped by 6.4% on Thursday, but global markets did not follow its lead
- US Federal Reserve Vice Chair Stanley Fischer said it is too early to assess the impact of recent market volatility on the US economy.
- Credit rating agency Moody’s this week cut Brazil’s sovereign credit rating to Ba2, a two-notch downgrade. All three major agencies now rate Brazil below investment-grade.
- After slumping sharply in December, US durable goods orders bounced back in January, rising 4.9%
- Nondefense capital goods orders excluding aircraft, a proxy for capital spending by companies, rose an impressive 3.9%
- Consumer prices in the eurozone rose a scant 0.3% on an annualized basis in January. This will keep pressure on the European Central Bank to add additional monetary policy stimulus at its policy-setting meeting in March
For the week, the S&P 500 increased by 1.58% for a year-to-date return of (-)4.69%.
Summary
IBD: Market in confirmed uptrend
GMI: 3/6- Sell signal since market close of December 10, 2015
BCI: I will remain focused primarily in defensive positions, selling out-of-the-money puts and in-the-money calls in a ratio of 3-to-1 over more aggressive positions.
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