Covered call writing education must include debunking the myths associated with this strategy. When certain concepts are repeated often enough, they become accepted as truths whether they are accurate or false. The purpose of this article is to refute five of the most egregious of these misrepresentations.

 

1. Covered call writing should be used in flat markets only

Truth: This strategy can be crafted to succeed in all market conditions. We accomplish this by selecting the most appropriate underlyings in bull (more volatile) and bear (less volatile) markets and the best options in bull (out-of-the-money) and bear (in-the-money) markets. We are also prepared with our bull/bear exit strategies.

 

2. We should focus in on stocks and options that generate the highest returns

Truth: Option premium is directly related to the implied volatility (IV) of the stock or exchange-traded fund (ETF). Covered call writing is a conservative strategy with capital preservation a key requirement. By selecting high-IV stocks, we are converting the strategy to a risky one. Instead, set up an initial time-value return goal range that will manage the risk we are subjected to (2% – 4% in my case).

 

3. 90% of all options expire worthless

Truth: 10% of options are exercised but the other 90% includes 55% that are closed and 35% that expire worthless as shown in this chart:

Option Expiration Chart

 

4. We are forced to sell winners and retain losers

Truth: When we sell a covered call, we are accepting an obligation to sell the stock. However, that commitment can be cancelled by closing the short call or rolling the option. Mastering the exit strategy skill will leave us in control. The same holds true for under-performing stocks. We can first buy-to-close the short call and then sell the stock. As we manage our positions, our portfolio will consist of elite-performers that generate initial time-value premiums that meet our conservative goals.

 

5. Sell options prior to an earnings report to generate the highest returns

Truth: NEVER sell an option prior to an earnings release. There is too much risk associated with a disappointing report. Allow the report to pass and then write the call if the underlying meets our system requirements. Covered call writing is a conservative strategy where we can generate dependable modest returns that will beat the market on a consistent basis. Risk is to be avoided, not embraced.

 

Discussion

A critical component to our financial education is to debunk the long-standing myths pervasive in our society. By mastering the 3-required skills (stock selection, option selection and position management), we will unmask the truths of covered call writing and create opportunities to achieve the highest possible returns as we beat the market on a consistent basis.

 

Your generous testimonials

Over the years, the BCI community has been incredibly gracious by sending our BCI team email testimonials sharing stories as to what our educational content has meant to their families. Moving forward, we have decided to share some of these testimonials in our blog articles. We will never use a last name unless given permission:

Hi Alan,

Just a quick note to say that you did a Great Job as always during your Money Show presentation last week. I so appreciate your down to earth, stable advice that you always give– backed up with actual examples.

Thanks,

Tracy

 

Upcoming events

 

1. Michigan AAII Chapter webinar

Trading in a Low Interest-Rate Environment

Creating a 3-income stream strategy

Wednesday June 24th

7 PM

Login information to be sent to registered members (club and premium members)

 

2. Greensboro North Carolina AAII Chapter webinar

Covered Call Writing to Generate Monthly Cash-Flow

Option Basics and Practical Application

Saturday June 20, 2020

10 AM

Login information to be sent to registered members (club and premium members)

This presentation will include the basics of trading option, an overview of covered call writing and 4 practical applications of the strategy.

 

Alan speaking at a Money Show event

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Market tone data is now located on page 1 of our premium member stock reports and page 8 of our mid-week ETF reports.

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