Top Reasons For Writing Covered Calls In A Bull Market
- Author Nathan Wescott
- Published February 26, 2011
- Word count 491
Selling covered calls in a bull market is a concept that is sometimes criticized. After all, why set a cap on your upside potential when stocks are going up? But, if you are writing short-term options, trading around a news event (product or earnings announcement) then there is an argument to be made for getting some more downside protection and taking a possibly smaller gain. Here are 5 reasons why you may want to consider selling covered calls in a bull market:
Gains. After your stock has gone up in price the cautious investor will either sell some of the shares, or write some call options against the shares so that if they give back their gains you can capture some from the premium. These two ideas can be combined by selling covered calls that are in the money on the shares you were planning on selling anyway, as a way to get a tiny bit more profit out of the position. Or, if you're still bullish then perhaps sell some near-term out of the money covered calls, so that you leave yourself some room for further appreciation.
Monthly income. If you have core positions that you are planning to own for a while then how about writing some out of the money calls on them to generate some income (even if they're rising in a bull market)? Depending how far out of the money you choose, you may need to sell several months worth of time instead of near-month (to cover the commissions for the trade).
Velocity. Sometimes a stock has risen quickly and the momentum investors are piling in. That kind of buying activity usually increases the call premium, making them 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 can be very volatile. It is best to keep the time to expiration short (i.e. sell the front month, and not several months out).
News. Prior to a scheduled product or earnings announcements it is typical for the option premiums to increase. But rather than buying into the anticipated news, consider selling the excitement by selling a covered call. The amount that the option is OTM or ITM (out of the money or in the money) should match your thoughts on which way the news will turn out.
Borrowing. Using margin to trade stocks can be dangerous. You can experience quick losses if there is a sudden move against you. One way to increase your safety cushion is by writing DITM (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 enough time to close out the position if you need to with smaller losses than if you had just held the stock outright.
Additional details about selling covered calls for profit can be found at Born To Sell, a site for covered call investors and buy and hold investors.
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