Q and A. Covered Call Writing in Today’s Volatile Market

Mark,

Most of my friends who write covered calls are choosing out of the money calls so they will not have to deal with losing their underlying stock.  Maybe they all need to read your book.

Also, please comment on how you feel in general about the covered call strategy in today’s extra-volatile market.

Scott

Hi Scott,

Writing covered calls makes me uncomfortable because there is simply too much volatility – and that translates into too much downside risk.  And if I were confident enough to believe that downside risk is minimal (I'm not) and chose to adopt that strategy in today's climate, I'd never write OTM calls.  I'd want the additional downside protection that comes from writing calls that have more premium – and that means calls that are at-the-money, or slightly in-the-money. 

I don't believe it's sound to base investment decisions on the possibility of a tax problem.  If an investor does not want to sell shares, then writing covered calls is the wrong strategy.

I understand the desire to write OTM calls.  It's the path taken by most investors because it allows for much larger potential profits – in case the stock rises significantly.  Seeking the maximum profit while ignoring potential losses totally ignores risk management.

As an aside, the writing of cash-secured naked puts is a strategy equivalent to writing covered calls.  My idea of selling ITM calls is equivalent to writing OTM puts.  Your friends are choosing to write naked ITM puts.  That's very aggressive and very bullish.  Nothing wrong with that, but I must remind you that risk and reward profiles differ for each trader, and my personal comfort zone (and yours) does not have to match that of your friends.

In today's volatile world, if I were bullish, I'd adopt a strategy with limited losses – and that's the purchase of call spreads or it's equivalent, the sale of put spreads.  Managing risk is the key to success when trading options.

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