Last update: July 2021
In last week’s message, we laid out the three primary avenues for using the financial markets to build wealth. Our discussion provided much-needed context for an intelligent conversation on portfolio structure. And by “portfolio structure” I mean how you allocate your trading account. After all, there are many strategies and systems and even more stocks available to deploy them on.
For today let’s focus on The Cash Flow Generator And Volatility Dampener. You’ll recall this method involved the following four steps:
- Step One: Build a diversified portfolio of stocks or ETFs that have listed options.
- Step Two: Sell covered calls on a monthly basis to reduce basis, increase the probability of profit, enhance returns and dampen volatility.
- Step Three: Buy protective puts to limit risk.
- Step Four: Invest more money in said portfolio each year to accelerate growth. Each time you accumulate another 100 shares, sell one more covered call.
How you structure this type of portfolio depends in large part on how much capital you have at your disposal. Because the covered call is the most expensive options strategy, you may be unable to carry more than one or two positions in a smaller account. Let’s walk through the logic of security selection; then we’ll build a model account together.
Pick Your Poison
When it comes down to building your cash flow account, you have two choices: use stocks or ETFs. Of course, you could also use some combination. The stock picking route offers higher risk, but higher reward. Plus, you have to deal with those pesky quarterly earnings announcements injecting large price gaps into the chart. If you can stomach the higher volatility and have a knack for picking quality, long-term growth candidates (or are piggybacking off of the Tackle 25 list), then this may be your thing.
Using ETFs offers a potentially lower risk, lower reward approach. The volatility will be dampened but so too will be the potential rewards. For our purposes today, let’s assume we want to sidestep the whole stock picking quandary and focus instead on building a globally diversified ETF portfolio.
The first order of business is to identify what segments of the market you want exposure to. Then you identify the most liquid ETF that represents it. Here are a few examples:
- U.S. large-caps: SPY
- U.S. small-caps: IWM
- Emerging Markets: EEM
- Oil & Gas: XOP
- Metals & Mining: XME
Let’s suppose these are the core areas you want exposure to and they offer adequate diversification to satisfy even the sternest risk manager. The second step is deciding what percentage of the portfolio you want to be allocated to each bucket. Covered calls present a unique challenge since you have to buy each security in 100 share increments to make it a viable position for call selling. Let’s add the cost of 100 shares to each ticker. Since you only have to put up 50% of the capital in a margin account, I’ll add the reduced cost as well.
- U.S. large-caps: SPY @ $278. 100 shares = $27,800 or $13,900 on margin.
- U.S. small-caps: IWM @ $155. 100 shares = $15,500 or $7,750 on margin.
- Emerging Markets: EEM @ $50. 100 shares = $5,000 or $2,500 on margin.
- Oil & Gas: XOP @ $35. 100 shares = $3,500 or $1,750 on margin.
- Metals & Mining: XME @ $38. 100 shares = $3,800 or $1,900 on margin.
If your margin is left untapped, acquiring 100 shares of each would cost $55,600. The respective percentage allocation to each is as follows:
- U.S. large-caps: SPY (50%)
- U.S. small-caps: IWM (28%)
- Emerging Markets: EEM (9%)
- Oil & Gas: XOP (6%)
- Metals & Mining: XME (7%)
The problem with allowing the cost of 100 shares to drive the allocation is the tail is wagging the dog. The way typical allocation works is the other way around. Decide first what allocation makes sense based on your desired exposure and diversification objectives, then figure out how many shares that translates into. For example, maybe you want less exposure to U.S. markets due to their lofty valuations. And, perhaps you want more to commodity-related names for more exposure to the inflation theme. I’d like to add some foreign developed markets (like Europe) into the portfolio, but liquidity and premium in the options listed for ETFs like VGK and EFA leave much to be desired.
Here’s an example of how the portfolio may be shifted to reflect your preferences:
- U.S. large-caps: SPY (30%)
- U.S. small-caps: IWM (20%)
- Emerging Markets: EEM (25%)
- Oil & Gas: XOP (15%)
- Metals & Mining: XME (10%)
What of Protection and Cash?
If you’re looking to acquire puts to protect you obviously have to have capital available for that. Suppose using the above allocation you end up owning around 900 shares of these ETFs. Further, instead of beta weighting let’s say you buy one put on each ETF for every 100 shares you own. You’d be looking at purchasing one put on SPY, IWM, and XME. And two to three puts on EEM and XOP. All told, the cost will run upwards of $3,000. Or, if you have a $50 to $60K account, roughly 5% of the portfolio will be dedicated to insurance purchases.
The final consideration is whether you want to be fully invested or not. Having some capital allocated to cash reduces the risk in the portfolio as well as provides dry powder to buy additional shares during corrections and bear markets. How much you hold in cash might depend on your comfort level with current market prices. If you think the market is overvalued and a bear market is imminent, then you’ll want to increase your cash levels. Alternatively, if you believe the current prices of the ETFs/stocks you’re buying are a bargain, then maybe you don’t hold excess cash at all.
There are countless possible variations to today’s allocation examples. But, this should have helped identify the critical pieces of the process and help you better discover what works for you.
Tackle Trading Resources on Covered Calls
Continue learning about this powerful options trading strategy: the Covered Call. Tackle Trading has all the resources you need to MASTER this strategy like a PRO.
Covered Call For Beginners [Free Articles]
Learn How to Repair a Covered Call Gone Bad!
Join Coach D for an in depth look at a dynamic Covered Call repair strategy on $GMCR.
Options 101: How to set Basic Stops on Naked Puts and Covered Calls
In this video tutorial, Coach T walks the team through how to set a basic stop on a covered call or naked put position.
Options 101: How to find the perfect Covered Call Candidate
In this video tutorial, Coach T from Tackle Trading walks through a research session for covered calls.
How to use the Theta Research Tool to find the best stocks for Cash Flow
In this video tutorial, Coach Matt goes through the latest edition of the Options Research Spreadsheet explaining how to use it to find the best stocks to cash flow.
Options 101: How to Add a Protective Put to A Covered Call
In this video, Tackle Trading’s Coach Tim explains when, how, and why a trader would buy a put option on a covered call position.
Tales of a Technician: The USO Covered Call Nerve Strike
I seem to have struck a nerve with my call for a reverse split in USO. And that’s a good thing.
Video Tutorial: How to Repair a Covered Call to Reduce Risk
Watch and learn as Coach D demonstrates how to roll a covered call down and out to offset risk and bring in more premium as he repairs a protective call write that has traded below the strike price and break-even price point.
Tales of a Technician: Theta and Covered Call Management
Just when I think I’ve exhausted my inventory of covered call insights I stumble upon yet another blog worthy concept. Today I’ll shine a light on how to identify the remaining profit in your trade, an essential skill for covered call management.
Tales of a Technician: Covered Calls: Weekly vs. Monthly
With the advent of weeklys options the choices facing option traders has multiplied ten-fold. But it shouldn’t be overwhelming.
How to Pick a Good Covered Call
In this article we will breakdown the philosophy, construction, and management of the Covered Call cash flow strategy.
Tales of a Technician: Your Covered Call Questions … Answered!
Listen up you covered call lovers. Today I’m tackling some common questions on how to get the most out of your beloved buy-writes.
Trade Journal Series: How to use the Theta Research to find Covered Call candidates
In this video tutorial, Coach Tim Justice teaches how to find the best candidates to trade the Covered Call options strategy using the Theta Research tool.
Tales of a Technician: Covered Call Alternatives for IRAs
How to leverage an IRA account by selling covered calls on long-term call options (aka LEAPS) instead of stock? Read on.
Options Theory: Collaring Earnings
Earnings season is upon us. Whether it’s a straight stock position, you’re holding for the long run, or one that you’re selling covered calls on there is a straightforward way to limit your risk.It’s called a collar.
Options Theory: What a Covered Call Trader REALLY Wants
I think I could write about covered calls and naked puts every single week and still have plenty to say at the end of the year.
Options Theory: Picking the Right Stock for Covered Calls
I received an email the other day from a trader that bought a few stocks and has been selling covered calls against them. He had questions. I have answers. Here we go.
Options Theory: Combating Volatility with Covered Calls
Nothing like a monster “V” shaped reversal to get the juices flowing, am I right? Count me among those suffering whiplash over the market’s death-defying whoops and whirls of late. Yesterday was particularly annoying for those short delta toting traders like me.
Tackle Today: Do you trade Covered Calls?
Last update: August 2021 ≈ Cash Flow and Growth ≈ I put a poll question in the clubhouse recently asking the Tackle Trading community a simple question: Do you trade Covered Calls? If you haven’t answered the question yet, you still can HERE. Of the 5 potential answers, the breakdown was interesting. 38% said YES
Tales of a Technician: When Covered Calls Move In-The-Money
Traders have all sorts of rules and guidelines for managing covered calls that move in-the-money.
Tackle Today: Meet the Covered Call
The Covered Call strategy is an old friend of Tackle Trading. This strategy is so cool that we can talk about it every single day and still come up with new ideas.
Tackle Today: Covered Calls for Cash Flow
One of the most popular techniques in the equity and options market is the Covered Call. A Covered Call involves the purchase of at least 100 shares of stock and then the sale of 1 call option against that stock.
Options Theory: Tips for Buying Puts with Covered Calls
Let’s talk about proper strike price selection for covered calls and protective puts.
Portfolio Protection For Beginners [Free Articles]
Long Put: IWM or RUT
In this video tutorial, Coach Matt walks thru how he has been handling the additional macro risk in the market by trading Long Put options on the IWM.
How to add Insurance to your Portfolio
In this video tutorial, Coach Matt takes a look at different ways to protect your portfolio accounts when the market goes south.
Protecting Your Money: Create your own Personal Gold Standard
Everyone invests. Everyone has money. Currency is a form of investment since the gold standard was removed from the currency system.
How to Protect Your Retirement
Coach Matt from Tackle Trading looks at how passive and active investors can insure their retirements against another potential market crash like in the sub-prime crisis of 2008-09.
Tales of a Technician: Tagging the Golden Goose: A Lesson in Portfolio Protection
You’re a goose chaser. Admit it. It’s the gold you seek. And that’s okay. You’re in good company. Most of us round these parts have been searching for the big bird for ages. Some have even tagged one.
Tales of a Technician: A Trick for Financing Portfolio Protection
Come lear a Trick for Financing Portfolio Protection.
I Bought Portfolio Protection…Now What?
Today is the day we layout a game plan for exactly how to manage portfolio protection.
Options Theory: Hedging Basic Series Part 1 – What is Hedging?
What is hedging? Come learn the basics in this 3-part series.
Options Theory: Hedging Basic Series Part 2 – Why do Traders Hedge?
In part one of our new series on hedging, we defined precisely what the concept means. Today we’re turning to the why.
Options Theory: Hedging Basic Series Part 3 – When to Place Your Hedge
With a sound foundation on the what and why of hedging, we’re now ready to dissect the devil. Namely, when do I place my hedge?
Options Theory: Hedging Basic Series Part 4 – How to Hedge a Naked Put
The way that you go about hedging varies depending on what your strategy is. Come learn how to hedge a naughty naked put.
Options Theory: The Protective Put
The options realm is an insurance marketplace where stock owners can acquire protection against loss in their beloved equities.
Options Theory: VIX Spikes and Portfolio Protection
Today I want to talk a bit about the impact VIX spikes have on the cost of portfolio protection.
Tales of a Technician: Managing Protective Puts in a Crash
It’s nailing the management of Protective Puts that separates the men from the boys. Allow me to offer up a few ideas.
Tales of a Technician: How to Trade in a Bear Market
The bears are roaming. And while their sudden emergence likely spelled losses for traders far and wide, the pain doesn’t have to persist. I look at this as a “fool me once, shame on you; fool me twice, shame on me” situation.
Options Theory: This is What Capitulation Looks Like
Contrarians in a bear market seek signs of capitulation. Specifically, evidence that bulls are throwing in the towel and abandoning their once beloved positions.
Tales of a Technician: Of Legacies and Long-term Investing
Herein we explore the perks of lengthening your time horizon and embracing Long-term Investing.
Options Theory: Protective Put Management
You have questions on how to protect a portfolio. I have some answers. You’ll find them here.
Trading Journals
Good traders keep excellent records. Quality trading journals are essential to your progress and growth as a trader and keeping good records will help you learn more from both your income and expense trades.
Learn more about HOW the Tackle Trading Journals can help you become a professional trader.
Reports [Premium Content]
The Weekly Premium Reports are a part of the PRO subscription.
Tackle Trading Playbook [FREE for PRO Members]
PRO Members now have unfettered access to the Tackle Coaches’ personal playbook containing thirty-one powerful trading strategies categorized according to the Options Greeks. Bullish, bearish, or neutral market conditions, this Playbook will help you dial up the right call more often and with greater confidence.
Financial freedom is a journey
Sign up now and gain unfettered access to all of the quality content and powerful Scouting Reports that our Pro Members enjoy for 15-days absolutely free with no strings attached and let us show you what your trading has been missing.
Legal Disclaimer
Tackle Trading LLC (“Tackle Trading”) is providing this website and any related materials, including newsletters, blog posts, videos, social media postings and any other communications (collectively, the “Materials”) on an “as-is” basis. This means that although Tackle Trading strives to make the information accurate, thorough and current, neither Tackle Trading nor the author(s) of the Materials or the moderators guarantee or warrant the Materials or accept liability for any damage, loss or expense arising from the use of the Materials, whether based in tort, contract, or otherwise. Tackle Trading is providing the Materials for educational purposes only. We are not providing legal, accounting, or financial advisory services, and this is not a solicitation or recommendation to buy or sell any stocks, options, or other financial instruments or investments. Examples that address specific assets, stocks, options or other financial instrument transactions are for illustrative purposes only and are not intended to represent specific trades or transactions that we have conducted. In fact, for the purpose of illustration, we may use examples that are different from or contrary to transactions we have conducted or positions we hold. Furthermore, this website and any information or training herein are not intended as a solicitation for any future relationship, business or otherwise, between the users and the moderators. No express or implied warranties are being made with respect to these services and products. By using the Materials, each user agrees to indemnify and hold Tackle Trading harmless from all losses, expenses and costs, including reasonable attorneys’ fees, arising out of or resulting from user’s use of the Materials. In no event shall Tackle Trading or the author(s) or moderators be liable for any direct, special, consequential or incidental damages arising out of or related to the Materials. If this limitation on damages is not enforceable in some states, the total amount of Tackle Trading’s liability to the user or others shall not exceed the amount paid by the user for such Materials.
All investing and trading in the securities market involves a high degree of risk. Any decisions to place trades in the financial markets, including trading in stocks, options or other financial instruments, is a personal decision that should only be made after conducting thorough independent research, including a personal risk and financial assessment, and prior consultation with the user’s investment, legal, tax and accounting advisers, to determine whether such trading or investment is appropriate for that user.
2 Replies to “Tales of a Technician: Portfolio Structure for Covered Calls”
Really great article.
Comments are closed.