Yes, this isn’t a hobby for me – it’s serious business with real money at stake. While this particular approach certainly isn’t for everyone, it happens to be one that meets (some of) my needs and that I’m comfortable with.

For fundamental information I do use Yahoo! Finance, as well as the fundamental data provided by my data provider. At the same time I also take note of information provided by various blogs and/or financial publications. Mainly here I’m looking for companies that are likely to offer a reasonably predictable trend of sustained and increasing earnings (and have a history of doing so) and – perhaps most importantly – whose stocks aren’t significantly overvalued.

I typically monitor somewhere in the neighborhood of 100-200 stocks at any given time for this strategy. Finding candidates for the watchlists has never really been a problem. It’s mostly overall market conditions that tend to have the greatest effect on monthly cash flow. I try to reduce that effect by diversifying my positions in different industries and sectors (i.e., spreading out my bets over segments with varying degrees of correlation), and by not initiating all my put (or call) positions at one time into a move (i.e., spreading out my bets over time at different market levels). While of course the monthly income level has varied from month to month to some extent, I’ve been pleased with how consistently I’ve been able to meet my average monthly goals so far.

As far as programs that allow backtesting of strategies that include options, I’m not aware of any easy way to do this. I think the most practical approach may be to just backtest strategies using the underlying instruments (stocks, futures etc.) themselves and then later just manually add any option strategy “on top”. AmiBroker probably has a better backtesting capability than MetaStock alone does, but may be more difficult to learn. I currently use MetaStock combined with TradeSim, which is tough to beat. In terms of price/performance, though, AmiBroker would be the obvious choice.

It’s interesting that you mention LEAPS, because I’ve planned for some time to experiment with a LEAPS strategy at some point. While there are a variety of LEAPS strategies that sound interesting, one in particular that I’d be inclined to try would be to buy deep in-the-money (ITM) LEAPS calls (I would want to pay as little time premium as possible) and trade them as stock surrogates, effectively gaining leverage over trading the stocks themselves. In addition, short-term calls could even be sold against the LEAPS call positions, for a kind of leveraged “covered call” strategy. I still hope to look into this idea further at some point.

Thanks again for your comments and thoughtful questions.

Thank you for the reply and detailed explanations. I think I’m starting to understand the bigger picture and some of the mechanics behind your trading style and the preparation required to leverage success.. I would like to say I’m very impressed by how thorough your process appears to be and well thought out. I take it you approach this like a business and not a hobby. Hopefully I can put the same principals to practice soon..

Regarding looking at the fundamentals, of a typical candidate/company, do you use Yahoo Finance for the specifics or via your Data provider and/or scan tool. When reviewing the fundamentals, are you keying off general financial stability and/or improving forward earnings or just a trend of sustained earnings. This is and area I have little experience with, so have some learning ahead of me.

When creating your watch lists, of possible candidates, typically how many stocks do you monitor ? Do you typically find a reasonable number of candidates on a continuous basis to make trades for your monthly cash flow, or do you experience periods of “dry times”.

To get started with my scans, I will be renewing my TC200 shortly. Before I do, I would like your comments on the AMIBroker regarding doing Back Testing, possibly with options ? I have a limited experience with Metastock some years ago, and back testing was a feature I think ( a friend introduce me to the concept), but options were not possible I recall or his data provider was limited ?

TC2000 was great for scans, but if I wanted to explore/study other trading strategies the only tool I could find was TradeStation. To high powered a tool for me, because I was looking for lower stress trading ideas.

Thank you for explaining your future IRA based mechanical trading system concept. As you mentioned, I was thinking more along the lines of a LEAP based options style that you were creating. I find the idea of a “mechanical trading” system very interesting, (based on stocks or options). Maybe it’s the engineer speaking or that I tried on several occasions (on paper only ) to trade a LEAP options system that used OTM options after I learned that the deltas were higher the further out you go. I thought I could capitalize on this, but wasn’t sure how to test. My point I guess is that I thought maybe your IRA strategy was based on a similar concept.

Have a few other questions, on your TA approach using regression channel, but want to try it first before asking crazy questions.

Thank you for your time and look forward to your future posts.

F.S.

In answer to your questions:

1.) Yes, I do check the OI and volatility of potential option candidates, but only to see to what extent they may affect liquidity and potential net return, respectively. I’m generally not selling options with the intent of trading in and out of them, so high liquidity isn’t a necessity, but at the same time I do want to see at least some activity and interest. Volatility in and of itself also isn’t something I look at specifically, as my main concern is whether there’s enough premium to sell to make writing a particular option worthwhile. That said, I’ll occasionally factor in implied volatility when choosing between selling a nearer-term or farther-term option.

2.) To clarify, I’m generally looking for stocks that are showing above-average upside strength in the intermediate term, which might be identified through breakouts and/or extreme “overbought” levels on daily (and/or weekly) RSI and momentum oscillators. I then try to use short-term pullbacks as put-selling opportunities. While I look for opportunities near support levels or trend lines, I don’t try to get too precise about my entry points because 1.) the market is rarely so cooperative, and 2.) options tend to be “blunt instruments” and I’m never sure at exactly what price of the underlying stock my option limit order will trigger.

3.) My limit orders to sell put options (call options if I own the stock) are for a specific option price that was extrapolated from the current option price, the current price of the underlying stock, and the estimated price of the underlying stock at which I want to sell the options. This projected option price can be calculated using a program like Option Wizard, or simply estimated.

4.) I do varying amounts of fundamental research on the stock candidates in my watchlists. At a minimum I’ll check key statistics like Price/Earnings, PEG, Price/Book, Price/Sales, etc. I’m not particularly concerned with high volume or institutional support – I’m just trying to minimize my risks of being put a stock that I’m not comfortable owning for a while.

The charts I show in my posts include a long-term linear regression channel, with the center line being the linear regression trend line and the two outer lines being parallel lines a distance of two standard deviations away. I like this as a simple way of looking at the “big picture.” I’m not a huge fan of moving averages and prefer this approach and support/resistance lines for most of my needs.

I’ve been using this particular strategy for about four years and have found that it’s working as it was intended – that is, as a way to generate consistent low-risk returns on a regular (monthly) basis. And yes, I’ve been quite satisfied with the results so far and have no plans to stop using this strategy. The only change I’ve really made since I started using this approach is that I’ve graduated more and more to focusing on strong performing stocks rather than trying to “bottom fish” on weak stocks, although I’ll still consider the occasional “beaten down” opportunity.

To clarify about my IRA account, the long-term system that I mentioned involves the purchase (and sale) of stocks, not options. (For tax purposes it would make more sense to implement the long-term stock system in my regular account and the put-selling strategy in my IRA, except that the purpose of the put-selling system is to be able to generate income that needs to be accessible on a regular basis.)

Still trying to pull the details together to create my trading process. Using you replys as my guide, I have a few more questions if I may.

1) Option selections- do you concern yourself with the OI on options ? What about the volitility ?
2) Using the RSI or MACD etc as your trigger, you indicated that you are looking for oversold/bought stocks but playing them as a contraian, do use/consider the 30/70% levels are a trigger on pull backs, or let the support levels of the trend guide your decision once you have identified a canidate ?
3) When doing you limit order pre-market, are you placing the trade on the stock to buy the option or the actual option price ?
4) Finding your canidates, you mentioned about stocks with strong fundamentals and divedend payers as choices. Just how deep do you dig into the fundamentals ? or look for stocks with high volumne, big floats and institutional support ?

I noticed on your screen shots for stocks, that you include in your posts, the trend channel is not just support and resistents, the channel has a mid point line as well I think ?. What TA do you use that provides the center trend, and do you find this better or usefull ?

I do have a general question I would like to ask about your strategy overall. Your posts/blog started in April 2005, so I’m dying to ask, how long have you been trading this style and have you found it profitable ? Have you found that you have had to tweak it some since starting ?

I have more questions and some comments on your last reply regading “long term options in IRA”, but I’ll save for another comment later..

Thank you again for your posts and willingness to share your time to reply. I have found then very helpfull, informative and interesting..

Kind Regards,
F.S.

P.S. Sorry about the spelling, I’m lost without a spell checker!

Yes, I generally run my stock scans almost every evening and on the weekends, so I’m almost always adding new candidates to my watchlist(s). Each morning, before the opening, I’ll usually place limit orders to sell puts on those stocks on my watchlists that seem to be presenting the best opportunities based on their action on the daily charts. I also check the financial news (i.e., CNBC and Yahoo! Finance) for announcements or other news on any stocks on (or sometimes not on) my watchlist(s) that might be offering interesting opportunities as well.

For example, in the case of, say, an analyst downgrade on a watchlist stock that is showing good intermediate- and longer-term strength, I’ll often place a limit order pre-market to sell puts on it in hopes of having it trigger at a good price into the likely weakness at the open. I estimate the option limit price based on how low I think the stock might trade intraday (using support/resistance, trend channel analysis etc.) and then extrapolate the current option price to the lower projected price of the underlying stock using Option Wizard, an Excel-based option analytics spreadsheet I purchased many years ago.

I’ll also check my watchlist stocks periodically on an intraday basis when I’m able to, using a stock quote ticker (101Quote) and intraday charting tool (QuoteTracker), but I don’t currently use realtime alerts (although I might decide to at some point). Here I’m just watching for any significant moves or other action that might give me a reason to take action. I often catch good opportunities this way, but the bulk of my positions are initiated from my pre-market-open limit orders that are based on my EOD analysis.

This is also true when I’m selling covered calls. Just as with my put sales, I’ll monitor the underlying stock(s) mostly on an EOD basis looking for reasonable entry points based on some basic technical analysis. I don’t use a hard stop loss in this account as I’m willing to go into “investor mode” (within reason) if need be in most cases when I’m put a stock that goes down, assuming it was originally chosen based on the criteria I mentioned previously. It may sometimes take a while, but sooner or later such stocks usually recover, giving me the opportunity to sell at a profit, or at least exit the position with a minimal or no loss.

However, this won’t be the case with my IRA account, in which I expect to soon begin trading stocks using a long-term mechanical approach that uses very precise stops and position-sizing rules. But that’s another topic, and maybe another blog…

Thank you for your reply and thorough explanations, I truly appreciate it..

I fully enjoyed your comments on your risk management style. Surely a different way of managing risk then I was thinking. Guess the key point for me is “diversification, small percentage of capital per trade and larger number of trades to spread the chance of risk”. Something I’ll surely consider rather then ‘spend to protect”.

With the risk of wearing out my welcome, I do have a few more questions if possible..(you probably expected they were coming . ..)
- Getting into the Trade….You indicated in an earlier reply that you work your strategy as low pressure trade. Looking for candidates after hours and then making trades the next day if I understood correctly.

With getting into the trade do you concern yourself with price etc when entering or just place a market or limit order after the market  is opening ?  or watch for reasonable prices for the options and then place the trade during the day…

-Getting out of the trades or looking for good times to place a CC on long positions .. Once your in a trade, Put or CC, do actively monitor them based on price or use a trailing stop, or realtime alerts ?

- When selling puts or CC, do you monitor the options prices to decided when to get  in or follow more of a consistent plan of: after expirations friday review your positions and then decide for the next trading day like over the weekend for Monday… ? or do you monitor your trades and long positions for opportunities EOD, looking for new trades plays… ?

Thank you for sharing your comments. Look forward to reading your new post this weekend as I continue to “plan my strategy”..

Thank you again and Happy Easter..

This approach is one I’m comfortable with, and allows me to “pull the trigger” on a consistent basis without being concerned too much about any one position. If I’m put a stock and it goes down for a while I don’t really worry about it (unless its fundamentals have changed significantly) as it isn’t going to have a significant impact on my account.

And I haven’t been tempted to use protective puts or collars against my stock positions because, as you note, I’m not really interested in “protecting” them – instead I usually want to sell calls against them with the intention of “cashing in” another monthly profit, either by having the options expire worthless or by having the stock called at a profit. At the same time, if a stock I’m long does seem to be trending higher I’ll try to give it room to move up before selling calls against it.

In a perfect world, of course, I’d never get put stocks at all – all the puts I sell would expire worthless and I’d just collect the premium month after month. Of course in the real world it’s inevitable that I’ll be put stocks on a regular basis with this approach, so being long a few (or many) stocks at various times is just an expected part of the process.

And, yes, it’s true that many dividend-paying (and large company) stocks have low option premiums compared to those of more volatile stocks, but really all I worry about is the potential net gain of a particular position – I’m generally looking for about 1%+ over a one-month period (based on the premium received against the unmargined capital set aside to pay for the possible purchase of the stock). I’m definitely opportunistic about initiating such positions, and will often sell puts into news-related downdrafts (which can result in temporarily increased premiums) or simply wait for a stock I’m following that’s otherwise in an intermediate-term uptrend to pull back closer to a strike price.

There are many times that I’m frustrated in my efforts – for example trying to sell puts on a low-volatility stock trading right in the middle of two strike prices – but I follow enough stocks that there are almost always a few each week that offer opportunities. I would say that most of the options I sell are out-of-the-money (OTM) or at-the-money (ATM), but depending on the circumstances I’ll sometimes sell partly in-the-money (ITM) options too.

I hope this helps answer some of your questions.

Thank you for feedback and additional insights into your approach.

In your comments you mentioned a few very important points for me personally that still are not clear just how one keeps it practical and cost effective. That being “Risk Management”.

To kind of put it in perspective, I’m a late comer to dealing with retirement. I have been in the technical world for about 28 years, it was only within the last 12 that I was also effected, like most by the vanishing pensions of corporate america. That’s when I really decided to get serious on growing and preserving my personal assets to fund my retirement. Having very little financial savvy about the markets, I started to read everything I could (too much I think..).

So my personal driving force now is to try and pull together the pieces to create a process that will allow me to grow those assets and reduce the risk of loss. I’m conservative so slow and steady works for me.. If along the way I can learn

Back to the Risk Management, I have been considering using protective puts or collars as a way of asset protection. Its not clear yet if this too costly and if I should consider plays against the sectors, the market or individual plays.

I was considering using a 3% rule per each trade, but maybe your method of 5% is more reasonable..

When one is put the stock, and you start to make the CC plays, do you do it with the intention to have it called away, or just keep rolling it monthly ?

I like your idea of looking for stocks that pay dividends, but with my limited exposure it always seemed the premium was rather low. Is this why you find as well or do you try to balance the strike price and the premium (ATM, OTM etc..).

Thank you for any comments you are willing to share..I have some new homework for the weekend based on your last posts.

Regards, F.S.

Thanks again for your comments and interest. I also have an engineering background (among other things), and have been involved in the markets for over 25 years. I experienced some “analysis paralysis” too at one point, and I think some of the things that helped me get past that were finding an approach(es) that suited me, finding an approach/system that I was confident in (through backtesting etc.), incorporating risk management techniques into my approach(es), and realizing that technical analysis isn’t the most important component of a successful methodology.

For scanning for stock candidates, I currently use MetaStock with QuotesPlus (which has its own scanning-capable software) for end-of-day data, but AmiBroker is probably just as good (if not better) in most respects and I think can be even used with free EOD quotes from Yahoo.

When screening for candidates, I look for stocks displaying abnormal strength (or weakness) on a daily and/or weekly basis. This could be something as simple as scanning for stocks with extreme momentum oscillator or RSI readings. Extreme levels on these oscillators are often interpreted as indicating “overbought” (and “oversold”) conditions (which may indeed be the case in the short term), but I’ve found that more often than not they’re indicating that, ultimately, the current trend likely has further to go.

Good luck in your options trading. Please feel free to comment, question, or post further on the development of your approach. I look forward to hearing more about it.

Thank you for reply and willingness to share your approach and comments.

I have been studing options and technical analysis for last 8 years. I’m and engineer by training so suffer the “paralyses analysis” to often…

Within the last 4 years, I decided to get seriuos and started looking and searching for ideas that also would allow me away to do this on a monthly bases. (Yup, same dream as other I guess to do this fulltime) I have dabbled in many options trategies but have never been comfortable with any but the idea of selling Puts.

The Put Selling idea is the only one that seemed to stick with me but I also keep reading all the “bad” references to how risky it was. The idea of combining the CC concepts also seemed reasonable but didn’t click. I just couldn’t seemd to organize the process into something that made sense.

Then on one of my searchs I found a reference to your blog/site but don’t recall now where.

When I found it and started reading your posts, I started to see some relationship or process that may work for me (your process). I have only been tracking your posts honestly as papertrades for while to see if it would work for me.

Your recent reply here is giving me some hope that maybe I can pull this off as well and that maybe some profts monthly as possible.

I have used TC2000 for finding canidates, as well. I reviewed Metastock but the price with combined feed seemed a little pricey.

I’m still trying to see how one creates a simple scan that fits your style of playing options. I will try to use the ideas you shared and see how it will work for me.

thank you again for sharing your posts and additional comments. I will try not to ask to many questions…

Regards..