Rising Market Makes For Prudent Covered Call Investments
Everyone who owns stocks loves a bull market. But as stocks keep going up, investors should consider covered calls. I know… why would you want to put a max on your upside just as stocks are rising? Well, there are several reasons, actually. Perhaps there is an upcoming earnings or product announcement? Or maybe you are investing on margin. There are valid arguments to be made for increasing your safety net by taking a possibly smaller profit. Let’s look at a few of the reasons you may want to sell covered calls as stocks are rising:
Take some gains. After a nice run up in stock price it is wise to either reduce your position, or write some calls against it so that if the stock gives back some of its recent gains you can capture some from the call premium. These two points can be combined by selling covered calls that are ITM (in the money) on the portion of the stock you were planning on selling anyway, as a way to get a bit more profit from the position. Or, if you’re still very bullish then try writing some near-term OTM (out of the money) covered calls.
Monthly income. If you have core positions that you plan to own for the long-term then why not write some out of the money calls on them to generate some extra 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 premium instead of near-month (to cover the commissions for the trade).
Velocity. Sometimes a stock rises quickly and the momentum investors are piling in. That kind of buying activity usually increases the call premium, making the calls very attractive to sell. In these cases you may want to write 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 near month, and not several months out).
Pending news. Before a scheduled news announcement (eg. AAPL with respect to Verizon iPhone, or any company before an earnings announcement) the option premiums tend to 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. Using margin to invest in 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 fast move down, but the intrinsic value and time premium 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.
This insight on covered calls is brought to you by Born To Sell. Investing in emerging markets can be tricky; it’s a good idea to use a diversified strategy with an emerging market ETF.
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