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This
theory assumes that covered calls are a neutral-to-bullish
strategy and should only be written in a bullish
market, ideally. Some writers allow that covered
calls can be done in a neutral (ranging) market,
but admonish us to be careful. Well, I try
to be careful all the time. The main problem
is that the "bullish" belief system
assumes a lot.
First,
that covered writing in a bull market is somehow
intrinsically safe. Yet my worst loss ever
happened in a bull market. Believe me, you
can write a disastrous stock in a great market.
Think about this: we've been in an up market
since back in January 2003 (although most
of 2004 was ranging), yet many people took
a hit when the market corrected in May 2006.
Merely being in an uptrending market is no
guarantee of success.
Second,
diagnosing exactly what the market is doing
sometimes involves pure guesswork. For example,
when a bear market ends and a new bull market
(or at least a new uptrend) begins, it takes
a while before it clearly is a bull movement
- it could've just been a bear rally. You
would miss a lot of a new uptrendt before
deciding it is bullish.
And who decides that it's a bull market, exactly?
It takes forever for everyone to agree that
it really is an up market, and by the point
unanimity is achieved, the bull market is
about over or getting long in the tooth. This
isn't a very useful metric, is it? You know
the old definition of pornography... we know
it when we see it. Except we seem to disagree
more about what the market is doing than whether
a particular picture is pornography.
Third, the
bullish school assumes that covered writers
are helpless if the stock is dropping. But
the covered writer can write deeply in the
money and can always roll down - the extremely
high DITM premium gives huge downside protection.
We can always roll down and out a month or
so for fatter premium and more protection.
I have found that by sticking to the strongest
companies, writing a down market (except one
that is correcting, obviously) can be done
without much difficulty. Avoid stocks dropping
against a good market, though.
Fourth, Wall Street and many stock
gurus pushing the buy-and-hold school of stock
investing exhort us to hold on to "good
stocks" through thick and thin; they
say don't cut and run just because the stock
is down with the market, in other words. But
they also tell us that covered calls, by definition
a strategy involving short-term trades that
give the stock much less time to hurt us,
are dangerous in down markets. How can writing
the best companies in a down market be more
dangerous than holding on to them during their
entire drop through a bear market phase?
If the stock goes down on the covered writer
more than anticipated, can't the covered writer
hold onto them, just like the stock investor,
but unlike the stock investor keep wringing
premium out of them... writing deep ITM calls
and them buying them back, rolling the calls
down with the stock's decline? Of course we
can. Unlike the investor, though, we're pulling
an income out the asset.
Fifth,
it ignores the fact that there always are
stocks outperforming a declining market. For
example, many stocks took a hit beginning
the second week of May 2006 when the market
corrected. But some stocks took a very small
hit and quickly recovered. Many stocks, though,
especially the tech stocks and the weak companies,
took a big hit, and many have not come back.
When institutional investors get nervous,
there is a flight to quality out of weaker
stocks. So tech stocks got a double whammy
- they got hit by the pullback and hit again
as money drained out of them into better,
more boring companies. Stock selection matters
greatly... being in a bull market is no justification
for assuming that tomorrow will be as good
as today.
Here's another example you'll enjoy: In
2002 I had occasion to print out one of the
Real Time Lists™ (the S&P 100 list),
four weeks before expiration. Back then the
list only had 15 trades on it - today there
are as many as 30 - and there was one duplicate,
so it featured 14 different stocks. In that
four-week period the Dow Jones Industrial
Averages lost 1,000 points. Yet 12
of the 14 trades won outright at expiration
and the other two could easily have been managed
without a loss. Look at an INDU chart for
mid-2002 and you'll see what I mean.
I think the "bull market" dictum
is not a useful piece of advice. It flies
in the face of my direct experience, and the
experience of many of our long-term members.
Sure, it's great to write in a bull market
(just remember May 2006, though), but it's
not the only time we can write. We covered
call writers are lucky that way.
*
* *
I
know that it's not easy to learn covered call
writing from a book or web page. Even though
CallWriter offers more content on covered
call writing (much of it freely available
to all) than anyone, even sites like CBOE,
web pages don't provide dynamic instruction.
If you really want to learn how to get consistent
success at covered calls, please come to one
of my seminars. You'll leave them knowing
how to write covered calls properly. And if
you're unsatisfied at one of my seminars,
we have a money-back guarantee - which no
one has ever asked for.
Please
pardon the commercial, but I talk to people
all the time who go to seminars on trading,
some of them horrendously expensive, but who
haven't even learned how to pick a trade.
And even after taking a lot of your money,
some of these companies charge high fees for
access to tools and information on their websites.
Not CallWriter.
For one low monthly charge, you get everything
on our website, no holding back.
Insider
Transactions:
I
came across an interesting article
by Mark Hulbert featured in MarketWatch about
insider transactions recently. As you may
know, strong insider selling can be a warning
about the stock or the market. Whenever a
company's fortunes dim, we always see a pattern
of massive insider selling back down the road,
sometimes more than a year before the negative
news is released. They know. Corporate insiders
also have a much better handle than the public
on the economy, so a major downturn in the
market usually is preceded by massive insider
selling as they batten the hatches and take
money off the table. The stock market is perhaps
THE leading economic indicator, and usually
rises (falls) many months before an economic
upturn (downturn).
It's
harder to read the tea leaves of insider transactions
now than in years previous, because such a
huge percentage of insider compensation nowadays
comes in the form of stock. They naturally
sell more when the market is really up, to
get the best price, the same as anyone else.
But insiders vote with their feet. Whether
they're staying or going is indicative of
what they really think. Hulbert quotes Professor
Nejat Seyhun of the University of Michigan,
who studies insiders' behavior, who notes
that the normal ratio of insider selling to
buying these days is about 6.5 to 1.
The current ratio is only 3.2 to one,
less than half the norm - and even that is
down from the week before.
So
insiders are not particularly nervous about
the economy. This is no guarantee the market
will range where it is, and it's certainly
no guarantee it wil continue to rise. But
the savviest folks in the land are not running
for the exits, and that is some comfort about
the economy and the stock market. |