Selling covered calls in a rising market is a concept that is sometimes criticized. After all, why set a max on your upside potential when stocks are going up? But, if you are writing short-term options, trading on margin, or trading around a news event (product or earnings announcement) then there is an argument to be made for increasing your downside protection and taking a possibly smaller gain. Here are 5 reasons why you may want to sell covered calls in a rising market:
Taking some off the table. Greed is good, but don't be too greedy. After a nice run in a stock it is smart to either (1) sell some of the stock, or (2) write some calls against it so that if it gives back some of its recent gain you can capture some profit from the call premium. Often these ideas can be combined by writing covered calls that are in the money on the portion of the stock you want to sell anyway, as a way to eek out a bit more profit from the position. Or, if you're still bullish then try writing some near-term out of the money covered calls.
Recurring income. You may have some core positions that you plan to own for a while. Well, why not write some out of the money calls on them to generate some extra income (even if the stocks are rising in a bull market)? You can set the max potential as high as you like (by choosing the strike price). Depending on how far out of the money you choose, you may need to sell a few months worth of time premium instead of one-month in order to cover the transaction costs.
Velocity. Maybe a stock has risen quickly and the momentum traders are piling in. That kind of activity usually increases the call premium, making the calls very attractive to sell. In these cases you may want to sell a DITM (deep in the money) covered call. But it's important to pay attention and watch the stock closely because momentum stocks are very volatile. It is best to keep the time to expiration short (i.e. sell the near month, and not several months out).
Pending news. Before a big news announcement (eg. AAPL with respect to Verizon iPhone, or any company before an earnings announcement) the option premiums increase. Rather than buying into the hype, consider selling it by selling covered calls. The amount in or out of the money should scale with your opinion of which way the news will fall.
Borrowing money. Using margin dollars to invest can be dangerous. You can experience quick losses if there is a sudden move against you. One way to increase your protection is by writing deep in the money calls against your positions. You may still have losses if there is a sudden move down, but the time premium and intrinsic value should buy you time to close the position with smaller losses than you would have had if you had just held the stock long.
Taking some off the table. Greed is good, but don't be too greedy. After a nice run in a stock it is smart to either (1) sell some of the stock, or (2) write some calls against it so that if it gives back some of its recent gain you can capture some profit from the call premium. Often these ideas can be combined by writing covered calls that are in the money on the portion of the stock you want to sell anyway, as a way to eek out a bit more profit from the position. Or, if you're still bullish then try writing some near-term out of the money covered calls.
Recurring income. You may have some core positions that you plan to own for a while. Well, why not write some out of the money calls on them to generate some extra income (even if the stocks are rising in a bull market)? You can set the max potential as high as you like (by choosing the strike price). Depending on how far out of the money you choose, you may need to sell a few months worth of time premium instead of one-month in order to cover the transaction costs.
Velocity. Maybe a stock has risen quickly and the momentum traders are piling in. That kind of activity usually increases the call premium, making the calls very attractive to sell. In these cases you may want to sell a DITM (deep in the money) covered call. But it's important to pay attention and watch the stock closely because momentum stocks are very volatile. It is best to keep the time to expiration short (i.e. sell the near month, and not several months out).
Pending news. Before a big news announcement (eg. AAPL with respect to Verizon iPhone, or any company before an earnings announcement) the option premiums increase. Rather than buying into the hype, consider selling it by selling covered calls. The amount in or out of the money should scale with your opinion of which way the news will fall.
Borrowing money. Using margin dollars to invest can be dangerous. You can experience quick losses if there is a sudden move against you. One way to increase your protection is by writing deep in the money calls against your positions. You may still have losses if there is a sudden move down, but the time premium and intrinsic value should buy you time to close the position with smaller losses than you would have had if you had just held the stock long.
About the Author:
If you want to know more about covered call options there are more details at Born To Sell's site. Selling call options on stock you own is the most common of all option-based strategies. See how here: https://www.borntosell.com/covered-call-tutorial/call-options.
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