Selling Covered Calls In A Rising Market

Selling covered calls during a rising market sometimes gets a bad rap. And it is partially deserved. Yes, it can be sub-optimal to put a cap on your upside when stocks are booming. 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 potentially smaller gain.

Some things to keep in mind when deciding to sell covered calls in a rising market or not:

Reason #1: 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 the point where they're just too juicy to not try a deep in the money buy-write. These can be highly volatile so it is wise to keep the durations short (i.e. sell the near month, and not 3-5 months out).

Reason #2: Pending news

Before a big news announcement (eg. earnings announcement) the option premiums increase. Rather than buying into the hype, consider selling the hype by selling covered calls. The amount in or out of the money should scale with your opinion of which way the news will fall.

Reason #3: Margin risk

When trading on margin you need to be extra careful. You can get hurt quickly if there is a sudden move against you. One way to increase your protection is by selling deep in the money calls. You may still lose money if there is a dramatic move down, but the call premium 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.

Reason #4: Taking some off the table

Greed is good but don't be too greedy. After you've had a nice run in a stock it is prudent to either (1) sell a portion of the stock, or (2) write some calls against it so that if it gives back some of its recent gain you can preserve some profit from the call premium. Often these can be combined by selling covered calls that are in the money on the portion of the stock you want to sell anyway, as a way to eek out a bit more profit from the position. Or, if you're still very bullish then try selling some near-term out of the money covered calls.

Reason #5: Partially cover

If you can't make up your mind if you should cover or not then consider selling covered calls on part of your position. You'll end up being half right and half wrong at the same time, but at least you won't have been all wrong.

Reason #6: Monthly income

If you have core holdings 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 instead of near-month (to cover the transaction costs).

Mike Scanlin is the founder of Born To Sell and has been writing covered calls for a long time.