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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.
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