Selling covered calls in a rising market is a strategy that is sometimes criticized. After all, why set a max on your upside when stocks are rising? 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 getting some more downside protection and taking a potentially smaller gain. Here are 5 reasons why you may want to consider selling covered calls in a rising 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 writing covered calls that are ITM (in the money) on stock you were planning on selling anyway, as a way to get a tiny bit more profit out of the investment. Or, if you’re still bullish then perhaps sell near-term out of the money covered calls, so that you leave yourself room for further appreciation.
Recurring income. You may have some core holdings that you plan to own for the long-term. Well, why not sell 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.
Momentum. Maybe a stock has risen more than the market recently and the momentum traders are doubling down. In doing so they usually increase the call premiums to a point where they’re just too juicy to not try a deep in the money buy-write (eg. LULU, NFLX). These can be volatile so it is wise to keep the durations short (i.e. sell the near month, and not 3-5 months out).
Pending news. Before a scheduled news announcement (eg. AAPL with respect to Verizon iPhone, or just about any company before an earnings announcement) the option premiums tend to increase. Rather than buying into this hype, consider selling it by writing covered calls. The amount in or out of the money should scale with your opinion of which way the news will fall.
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 net is by writing DITM (deep in the money) calls against your holdings. You may still have a loss 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.
Click here to visit Born To Sell’s website on covered call options. Covered call writers earn their income from capturing time premium. See how at borntosell.com/covered-call-tutorial/time-premium