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 rising? However, 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 consider selling covered calls in a bull market:
Taking some off the table. Don’t be too greedy. Afteryou’ve had a nice run in a stock it is smart to either (1) sell a portion of the stock, or (2) write some covered calls against it so that if it gives back some of its gain you can capture some profit from the option premium. Often these 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 get a bit more profit from the position. Or, if you’re still bullish then try selling some near-term out of the money covered calls.
Recurring income. You may have some core holdings that you plan to own for a while. Well, why not sell some out of the money calls on them to generate some income (even if the stocks are rising in a bull market)? You can set the upside 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 several months worth of time premium instead of one-month in order to cover the transaction costs.
Momentum. Maybe a stock has risen a lot recently and the momentum traders are increasing their bets. 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 probably wise to keep the time horizons short (i.e. sell the near month, and not 3-5 months out).
Pending news. Before a predicted news announcement (eg. AAPL with respect to Verizon iPhone, or any company before an earnings announcement) the option premiums 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 is likely to go.
Margin. When using margin dollars to trade you need to be extra diligent. You can feel pain quickly if there is a sudden move against your positions. One way to increase your protection is by selling DITM (deep in the money) calls. You may still have a loss if there is a dramatic move down, but the time premium and intrinsic value should buy you enough time to exit the position (if you need to) with fewer losses than you would have had if you had just held the stock long.
To learn more about covered calls, check out Born To Sell. To learn more about covered call trading, check out borntosell.
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