Options trading basics teaches us that the VIX or CBOE Volatility Index reflects the market’s expectation of the upcoming 30-day volatility. It measures market risk and is also known as the investor fear gauge. With this in mind, covered call writers are faced with a dilemma. Increased market volatility will translate into higher option premiums because the time value component of the premium is directly related to volatility. On the other hand, a high overall market volatility increases our risk as share value can plummet and erase our initial gains. So, is a higher VIX a positive or a negative?

 

Evaluating the VIX from a covered call writing perspective

One question that is frequently posed to me is that if the VIX is low do we stop selling calls because of lower premiums? This implies that a high VIX is a positive for covered call writers. Let’s take a look at an extreme example in 2008 when the VIX went from the 20 – 30 level to the 70 – 80 level in the last 4 months of the year before it ultimately moved lower:

 

CBOE Volatility Index and covered call writing

VIX in 2008

 

As a general rule, the VIX and the performance of the overall market (S&P 500) are inversely related as demonstrated in the chart below where the market takes a dive in the last 4 months of 2008:

Volatility, market performance and covered call writing

S&P 500 in 2008

To confirm this relationship, let’s look at a comparison chart of the VIX and the S&P 500 in the 5 years after the 2008 recession. In the chart below, note how when the VIX (black line) declined, the overall market (blue line) accelerated and vice-versa. Whenever there was a short-term spike up in the VIX, there was a corresponding decline in the market performance (yellow fields):

The VIX and covered call writing

VIX vs. the S&P 500 from 2008 – 2013

 

The VIX in 2018

 

covered call writing and market volatility

Inverse Relationship of the VIX and the S&P 500

 

 

VIX and covered call writing

Covered call writing is a conservative strategy and those who use it are generally conservative investors looking to generate cash flow with capital preservation in mind. As such, a high VIX is no friend of covered call writers although we can use our common sense principles to manage those scenarios. A low VIX (under 20) is usually a positive for us because it means a more stable market and oftentimes a rising market as we experienced from 2009 through 2017 and into 2018.

How to manage a high VIX:

We can “stay in the game” by selling in-the-money strikes (purple field), using options with lower implied volatility (set goals at 1 – 3% instead of 2 – 4%) and use low beta stocks from our premium reports and ETFs.

How to manage a low VIX:

This is one of the factors that will give us the confidence to take a more bullish stance and sell at-the-money and out-of-the-money strikes (yellow field) with higher beta stocks and higher implied volatility options.

The exit strategies selected in these environments are detailed in my books and DVD Programs.

 

Discussion

The VIX is a factor that should be considered in our covered call writing decisions. It should neither be feared nor embraced but rather managed using the fundamental, technical and common-sense principles of the BCI methodology.

 

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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:

Encyclopedia book review on Amazon.com:

Hello Alan,

Thank you very much for all the knowledge you teach, it really changed my life.

Sincerely,

Garoda

 

Upcoming events

September 14, 2019: Charlotte Chapter of The American Association for Individual Investors

“Converting Non-Dividend Stocks to Dividend-Like Securities”

Live webinar (link to follow)

Saturday from 10 AM – 12:PM ET

 

September 27, 2019 at 1:30 PM ET: Philadelphia Money Show

“How to Select the Best Options in Bull and Bear Markets”

 

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Market tone data is now located on page 1 of our premium member stock reports.

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