Option selection is the second required skill when selling call and put options. On 9/26/2017, George shared with me a trade he executed with Biogen, Inc. (NASDAQ:BIIB). An in-the-money strike was sold and share price immediately accelerated. George was inquiring about how deep in-the-money (ITM) the strike prices should be set.
George’s initial trade
- Buy 100 x BIIB at $313.80
- Sell (1-month) $307.50 call for $8.20
- 9/26/2017: Stock trading at $318.46
We use in-the-money strikes when concerned about potential price decline of the underlying security.
Calculating initial timer-value returns
Using the multiple tab of the Ellman Calculator, we see an initial time-value return of 0.6% with a downside protection (of that initial profit…not breakeven) of 2%. When evaluating if this was the best strike to select we must first define what the goals were prior to entering the trade. If the return goal and protection goals were met, then yes this was the appropriate strike. If not, a more relevant option should be considered.
One month later
With BIIB trading at $328.78 on 10/23/2017, let’s view the option chain for in-the-money strikes and assume a goal of 2% – 4% for initial time value returns (my personal preference):
We will evaluate three in-the-money strikes ($315.00, $317.50 and $320.00) by entering the information into the multiple tab of the Ellman Calculator:
The initial time value returns of all 3 strike prices approximate our 2% – 4% 1-month goals. If we are looking to generate the most protection of the time value profit, we would favor the $315.00 strike (4.2%). If we preferred the greatest time value profit, then the $325.00 strike should be considered. The $320.00 strike is an excellent compromise.
Discussion
When deciding on which in-the-money strike to select, initial time value goals must first be established. From there, the amount of profit protection should be considered. Once those two components are defined, strike selection will become apparent.
Market tone
This week’s economic news of importance:
- Retail sales march 0.6% (0.4% expected)
- Housing starts March 1.319 million (1.255 million expected)
- Building permits March 1.354 million (1.321 last)
- Weekly jobless claims 4/14 232,000 (230,000 expected)
- Leading economic indicators March 0.3% (0.7% last)
THE WEEK AHEAD
Mon April 23rd
- Markit manufacturing PMI April
Markit services PMI April
Existing home sales March
Tue April 24th
- Case-Shiller home prices Feb
- Consumer confidence index April
- New home sales March
Wed April 25th
- None scheduled
Thu April 26th
- Weekly jobless claims through 4/21
- Durable goods orders March
Fri April 27th
- GDP Q1
- Consumer sentiment index April
For the week, the S&P 500 moved up by 0.52% for a year-to-date return of (-) 0.13%%
Summary
IBD: Market in confirmed uptrend
GMI: 6/6- Sell signal since market close of March 23, 2018
BCI: Selling 2 in-the-money strikes for every 1 out-of-the-money strike for all new positions. Earnings season should be a positive for the market.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
The 6-month charts point to a bearish sentiment. In the past six months, the S&P 500 was up 2% while the VIX (16.79) moved up by 75%. The VIX has calmed a bit more from the prior week.
Wishing you much success,