Selling covered calls in a bull market is a strategy 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), or trading on margin 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 bull market:
Taking some off the table. Don't be too greedy. Afteryou've had a nice run in stock price it is prudent to either (1) sell some of the stock, or (2) write some calls against the stock so that if it gives back some of its recent gain you can capture some profit from the option premium. Often these ideas can be combined by writing covered calls that are in the money on the portion of the shares 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 holdings that you plan to own for the long-term. Well, why not write some out of the money calls on them to generate some extra income (even if the stocks are rising)? You can set the max potential as high as you like (by choosing a high strike price). Depending on how far out of the money you choose, you may need to sell many months worth of time premium instead of one-month in order to cover the transaction costs.
Velocity. Sometimes 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 write a DITM (deep in the money) covered call. But it's important to 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).
News. Prior to a scheduled product or earnings announcements it is typical for the option premium to increase. But instead of buying into the anticipated news item, 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.
Margin. When trading on margin you need to be extra diligent. You can get hurt quickly if there is a sudden move against you. A common way to increase your protection is by selling DITM (deep in the money) calls. You may still lose money if there is a dramatic move down, but the time premium and intrinsic value should buy you time to exit the position (if you need to) with fewer losses than you would have had if you had merely held the stock long.
Taking some off the table. Don't be too greedy. Afteryou've had a nice run in stock price it is prudent to either (1) sell some of the stock, or (2) write some calls against the stock so that if it gives back some of its recent gain you can capture some profit from the option premium. Often these ideas can be combined by writing covered calls that are in the money on the portion of the shares 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 holdings that you plan to own for the long-term. Well, why not write some out of the money calls on them to generate some extra income (even if the stocks are rising)? You can set the max potential as high as you like (by choosing a high strike price). Depending on how far out of the money you choose, you may need to sell many months worth of time premium instead of one-month in order to cover the transaction costs.
Velocity. Sometimes 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 write a DITM (deep in the money) covered call. But it's important to 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).
News. Prior to a scheduled product or earnings announcements it is typical for the option premium to increase. But instead of buying into the anticipated news item, 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.
Margin. When trading on margin you need to be extra diligent. You can get hurt quickly if there is a sudden move against you. A common way to increase your protection is by selling DITM (deep in the money) calls. You may still lose money if there is a dramatic move down, but the time premium and intrinsic value should buy you time to exit the position (if you need to) with fewer losses than you would have had if you had merely held the stock long.
