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One
thing that should be emphasized is the fact that you simply
cannot ignore the prevailing market trend. If the market
is trending down, this fact is more important than the
stock's individual direction. That is, a stock will usually
counter-trend the overall market for only so long and
will correct. And the correction frequently is major.
For this reason, we are very hesitant to write a rising
stock in a dropping market. Conversely, it is always a
mistake to write covered calls on a stock that is dropping
in a rising market and showing greater weakness than the
market.
| Market
Trend |
How
it Works for Covered Calls |
| Strong
uptrend |
Covered
calls work superbly. This is the place to write out-of-the-money
calls for home-run returns. |
| Moderate
uptrend |
Covered
calls work superbly. The best returns come from at-the-money
and out-of-the-money calls. |
| Gentle
uptrend |
Covered
calls work very well. The best returns come from at-the-money
calls. |
| Trading
Range |
While
covered calls can work very well, the better strategy
is to write a stock when it has found support in its
trading range and will move back up. The best calls
are usually the ones at the money. If you are a good
timer, the most profits will come from out-of-the-money
calls. If you are a lousy timer, write in-the-money
calls. |
| Gentle
downtrend |
Covered
calls can work well but should be written at or in
the money. The emphasis should be on downside protection
in case the downtrend accelerates. |
| Moderate
downtrend |
Covered
calls can be written under these conditions, but they
should only be written deeply in the money in order
to get the most downside protection. The premium should
be at least 15% (preferably 20%) of the stock's price
. |
| Strong
downtrend |
Covered
calls are very dicey under these conditions. Our picks
did well in the 2000-2002 bear market, but it is not
easy. The same comments apply as to moderate downtrend,
except look for a premium that is at least 20% of
the stock's price in order to get enough downside
protection. |
One
question we always get is how on earth we can advise anyone
to write covered calls in a down-trending market. Don't
we know you can't do that? Well, we don't. First of all,
a downtrend can be anything from a very gentle one to
nearly vertical. Second, there are trading-range periods
in every down-trending market, during which covered calls
are easy to write. Third, the best companies don't lose
value like the flaky ones. Priceline may have gone from
$70 to $2 in the bull market crash, but WalMart didn't.
Actually,
it can be easier to write in a down-trending market than
in a channeling (ranging) market. The reason is that a
channeling stock will not always turn at the same point.
If they always hit the same support and resistance points
in the range, writing them would be child's play. But
they can pull back well before the last resistance point
is reached.
We
understand that many of you are more aggressive call writers
than we are here at CallWriter. And we also understand
that traders have to trade in a style that suits their
individual personalities. But we have learned over the
years what works best and what works consistently, which
is the reason for our conservatism. The hotter you write,
the more money you will make... but the more you will
give back to the market in the form of losses, too. The
name of the game is to KEEP the profits.
For
example, compare these two calls on an $18 stock:
|
Call |
Premium |
Flat
Return |
Return
if Called |
Breakeven |
Percentage
of
Protection |
|
20
Call |
$.75
|
4.1%
|
15.2%
|
$17.25
|
4.1%
|
|
17.50
Call |
$1.50 |
5.5% |
5.5% |
$16.50 |
8.3%
|
|
15
Call |
$3.75 |
4.1% |
4.1% |
$14.25 |
20.8%
|
Notice
in the above example how the percentage of protection
conferred by the premium is inversely related to the return.
That is, the smaller the return, the greater the protection.
This is pretty much generally true of covered calls in
all markets. Traders who like to write hot or believe
the stock will advance strongly before expiration would
opt for the 20 call's extreme return in the event the
stock is called out. Many traders would opt for the 17.50
call's high return and smaller downside protection. Traders
writing in a declining market or concerned about a pull
back would opt for the lower return but far greater protection
of the deeply in-the-money 15 call, which protects all
the way down to $14.25. It’s a
personal philosophy, but we would not hesitate to write
the 15, since there is plenty of glory in a 4.16%
return for a month or less.
There
are many tricks to the covered call writing game. And
we have learned the most important ones, which we have
distilled into the CallWriter Method and teach to our
members. We know how to trade with few and small losses.
We are, admittedly, fairly conservative traders. Our approach
is not for everyone. We have had people leave our service,
thinking we were sissies. But our historical trading average,
even through 2000, 2001 and 2002 is slightly better than
4 for 5 winners and 3% to 5% a month, because we are careful.
By
observing the essentials of the CallWriter Method and
applying trade discipline, you can also make a handsome
trading profit every month. Here is probably the best
piece of market advice you will ever get:
Getting
high trading returns is not difficult -
the hard part is to avoid giving them back to the market!
Ways
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Disclaimer
We
are not brokers, investment advisers or securities
analysts and do not recommend the purchase,
sale or holding of any security. Your use
of any information or strategy appearing in
this newsletter or on CallWriter.com is solely
at your own risk. We urge our newsletter subscribers
and CallWriter.com website members to do all
requisite and analysis and properly plan each
trade prior to making the trade and to manage
each trade effectively. Covered call and other
potential trades discussed in this newsletter
or on CallWriter.com do not constitute trading
recommendations by CallWriter or any other
person and are presented by solely for informational
and educational purposes. |
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