As the name implies, the Option Income Generator service is designed to produce income for investors on a monthly basis. However, we are not talking about a run-of-the-mill approach such as buying high-yielding stocks or bonds, which, in our opinion are flawed strategies. Instead, our proprietary trading service combines the power of tactical market timing with an easy-to-follow, conservative option writing strategy built to generate an income stream.
The service starts with keeping your account on the right side of the market. Toward this end the Option Income Generator employs State’s Daily Decision (DD) tactical market timing system, which is designed to profit from both rising and falling markets. The DD’s management strategy is very simple to define: We want to be fully invested in stock market indices (via ETF's) when stocks are rising and we want to be either in cash or short the market (again, via easy to use exchange traded funds) when stocks are falling.
The second part of the Option Income Generator service involves the creation of monthly income from the DD positions using a "covered call" options writing strategy.
A study released in September 2011 entitled "Risk Reducing and Income Enhancing Buy-Write Strategy" showed that investors who sell call options against a popular stock-market index make more money with less risk than investors who buy and hold that index.
The two strategies in the Option Income Generator create a multi-strategy, multi-manager approach designed to:
- Keep your accounts in tune with the market’s major trends
- Manage the risks of a severe market decline by moving to cash or being "short" the market
- Produce an income stream on a monthly basis
About the Service
The primary strategy of the Option Income Generator service is to strategically write out of the money options – more often referred to as "covered calls" – against current Daily Decision ETF positions, using both monthly and the relatively new weekly options on several popular ETF’s.
Commonly referred to as a "buy-write" or "covered call" strategy, the Option Industry Council found that over 15 years, investors who sold a call options that was 2% out-of-the-money and that expired in one month significantly outperformed the overall market index. (The service will sell calls higher or lower than 2% depending on market conditions.)
Two Income Generator Model Portfolios: Conservative and Active:
The Option Income Generator will be an actively managed service, with two different levels of service: Conservative and Active.
The "conservative" model will write covered calls with specific sell and buyback alerts on DD positions. Alerts will be issued at most a few times per month and in many cases only once a month.
The objective of the conservative approach will be to enhance revenues to one’s account by collecting additional option premium, through the sale of monthly options as long as there is an open Daily Decision position. Unlike other covered call services, options will not be sold until it is reasonably determined that a significant level of resistance (or support in the case of inverse positions) has been reached.
The second, more active, level of the service will offer active traders the opportunity to follow the sale and buyback of options against DD positions on a more frequent basis. The objective will be fairly frequent selling and buying back of options at weekly or even intraday levels of resistance and support, attempting to maximize income against the DD positions. (Those who follow the aggressive approach should be prepared to monitor alerts on a frequent basis).
As with any trading endeavor, there will be times when market calls are clearly off and a major move down or up is missed. However, the beauty of selling option premium against positions already established is that there really is rarely an out-of-pocket "loss", only the possibility of an "opportunity cost" if the options are not sold or bought back at precisely the right moment.
The Managers
The Option Income Generator is a true multi-manager program. StateoftheMarkets.com founder Dave Moenning will provide service with his proven Daily Decision tactical timing system while David W. (aka "The Underground Trader") will manage the covered call strategy in the service. David has over 20 years of financial markets experience with some of the biggest names in the business and in fact was deeply involved with the launch of major ETF’s to retail investors. He has been employing a covered call strategy successfully for over five years.
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How It Works
Let’s examine a very simple example (for illustrative purposes) of both approaches...
The Conservative Approach:
Let’s assume the Daily Decision enters a long position in the market on the SPY, at a SPY price level of $120. The Option Income Generator service would not automatically sell calls at that time but would likely wait until the next level of technical resistance (indicating that the market was "overbought"). For example, with an overbought condition in place, we would then sell a monthly call at a strike price of $124. If the market continues up without interruption until expiration, the seller of the call will collect the option premium sold and if the SPY closes the expiration period above $124, will be "called out" at the $124 price, realizing both the benefit of the increase in the underlying SPY position, as well as the option premium collected. (It is quite likely that we would then want to reestablish the SPY position on the next trading day after options expiration.)
If the SPY were to finish relatively flat at $120-$122 at expiration, the seller of the calls would simply collect the option premium and maintain the current SPY position, looking for another good opportunity to sell the calls of the next month. This approach has the potential to add significant value to the overall account over time.
If the SPY were to fall sharply and the DD service exited the underlying SPY position, the sold calls would be "bought back" at a profit as the SPY is sold and some of the loss in the overall position could be nicely counterbalanced.
The greatest risk to this approach is a nice problem to have, where there is an unusually explosive move higher in the SPY over the course of a month and some of that upside gain is forfeited because of the sale of calls. This would be the exception rather than the rule.
The Active Approach:
For the very active trader, the aggressive approach will also use established DD positions but will sell and buyback calls frequently, utilizing both monthly and weekly calls where appropriate. The benefits and risks of the approach are similar to those listed above in our simple example, but the opportunity for increased income is greatly enhanced. Intraday resistance and support levels will be closely monitored and there may be several "sales" and "buybacks" of calls each week, with each successful trade another revenue opportunity.
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Some Perspective
Many traders attempt to use a "covered call" strategy, thinking erroneously that it offers a great deal of protection against market downturns. Nothing could be further from the truth, as collecting 1-2% premium against a position which declines 10-15% is clearly a losing proposition over time.
The difference with the Option Income Generator approach is the benefit of using sophisticated models which help identify optimal entry and exit points for the underlying ETF positions, not to mention the willingness to "go to cash" or to take a short position in the market through an inverse ETF when the overall going in the market gets tough.
Testing The Approach
While it is virtually impossible to backtest an actively managed, dynamic process, there has been a great deal of study given to the covered call strategy. Some information from the CBOE is of some interest, as they track a hypothetical "buy-write" strategy on the SPX. This "passive" index is called the BXM, and simply assumes that the SPX (or SPY) is held over time, with slightly OTM calls sold once each and every month. This was backtested from 1988-2006 with the following conclusions:
- BXM generated superior risk-adjusted returns over the last 18 years, generating a return comparable to that of the S&P 500 with approximately two-thirds of the risk. (The compound annual return of the BXM was 11.77% compared to 11.67% for the S&P 500, and BXM returns were generated with a standard deviation of 9.29%, two-thirds of the 13.89% volatility of the S&P 500.)
- The risk-adjusted performance, as measured by the monthly Stutzer Index over the 18-year period, was 0.20 for the BXM vs. 0.15 for the S&P 500. A comparison using the monthly Sharpe Ratio yielded similar results (0.22 vs. 0.16, respectively), confirming the relative efficiency of the BXM over the 219-month study period.
- The BXM underperformed the S&P 500 during most rising equity markets and consistently outperformed the S&P 500 in all periods of declining equity markets, demonstrating the return cushion provided by income from writing the calls.
- The BXM generates a return pattern different from that of the S&P 500, offering a source of potential diversification. The addition of the BXM to a diversified investor portfolio would have generated significant improvement in risk-adjusted performance over the past 18 years.
While this data is helpful and informative, it is important to remember that the passive approach of the BMX is always fully invested in the market and only sells calls once per month at a predetermined and set time. This approach has obvious limitations but does detail the benefits of the covered call writing strategy.
The advantages of an actively managed covered call approach should be quite apparent, especially combined with the underlying model-based discipline of the Daily Decision service.
Let's Talk Price
The Option Income Generator is an institutional strategy that is now available to the general public. For just $169 per month (annual and quarterly plans that provide savings of 15% to 20% are also available) you can follow this pro level approach in your own portfolio. We estimate that subscribers will easily recapture their fees each and every month!
Wishing you green screens in your investment endeavors!
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The analysis and information in this report and on our website is for informational purposes only. No part of the material presented in this report or on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program. The opinions and forecasts expressed are those of the editors and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. Investors should always consult an investment professional before making any investment.
Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.
The analysis provided is based on both technical and fundamental research and is provided "as is" without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.
The information contained in the publications is provided by Ridge Publishing Co. Inc. (Ridge). One of the principals of Ridge, Mr. David Moenning, is also President and majority shareholder of Heritage Capital Management, Inc. (HCM) a Chicago-based money management firm. HCM is registered with the U.S. Securities and Exchange Commission as an investment adviser. HCM also serves as a sub-advisor to other investment advisory firms. Ridge is a publisher and has not registered as an investment adviser. Neither HCM nor Ridge is registered as a broker-dealer.
Employees and affiliates of HCM and Ridge may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Editors will indicate whether they or HCM has a position in stocks or other securities mentioned in any publication. The disclosures will be accurate as of the time of publication and may change thereafter without notice.
The Option Income Generator is a model portfolio. Model portfolios do not represent actual trading. It should be noted that backtested results do not take into account payment of commissions or reinvestment of dividends, have inherent limitations, incorporates the benefit of hindsight in the development of the model, and are for informational purposes only.
Your actual results may differ from results reported for the model portfolio for many reasons, including, without limitation: (i) performance results for the model portfolio do not reflect trading commissions that you may or may not incur; (ii) performance results for the model portfolio do not account for the impact, if any, of certain market factors, such as lack of liquidity, that may affect your results; (iii) the securities chosen for the model portfolio may be volatile, and although the "purchase" or "sale" of a security in the model portfolio will not be made in the model portfolio until confirmation that the email alert has been sent to all subscribers, delivery delays and other factors may cause the price you obtain to differ substantially from the price at the time the alert was sent; and (iv) the prices of securities in the model portfolio at the point in time you begin subscribing to our service may be higher than such prices at the time such stocks or options were chosen for inclusion in the model portfolio.
The S&P 500 is a stock market index containing the stocks of 500 large-cap corporations, most of which are US companies. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill. S&P 500 is used in reference not only to the index but also to the 500 companies that have their common stock included in the index. Investors cannot invest directly in the index.
Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.
