Here's a 1949 quotation from the popular early television series, 'The Lone Ranger': "With his faithful Indian companion, Tonto, the daring and resourceful
masked rider of the plains led the fight for law and order in the early
West. Return with us now to those thrilling days of yesteryear. The
Lone Ranger rides again!"
Is it possible for a popular, bullish strategy to be gaining in popularity during a bear market? Can the covered call strategy return to yesteryear's glory?
Abnormal Returns provides links to good stuff in the financial blogosphere – articles you may otherwise miss. They recently pointed Adam and his Daily Options Report to the Wall Street Journal. Adam commented: "Seeing lots of pro-buy-write articles lately. Such as this one in the Journal." Then the idea of writing covered calls on RIMM was discussed.
Adam is not a big fan of writing covered calls and feels that:
"you don't necessarily get compensated enough for the volatility of the stocks themselves."
"You have to always compare a buy write to how you would do just simply owning the stock."
These comments express the opinion: when option premium is high, it's still not high enough to give up the large potential upside move for the limited downside protection. If the markets makes a big move – and that's more likely now than ever before – then it may be better to buy the stock, if bullish.
I see things differently. When I am willing to write covered calls (and I prefer less risky strategies (credit spread, iron condor) right now, I'd rather collect a fat option premium in a stock I want to own, even though that limits my potential gains. If the stock rallies and I am assigned an exercise notice, that's good enough for me. If the stock doesn't rally, I would accept the limited protection of that option premium. Deciding if the premium is 'fat' enough is the difficult decision.
This is what makes options such versatile investment tools. They allow users to adopt different methods, and when considering a specific strategy, there are different points of view – allowing you to find options strategies that allow you to remain within your comfort zone.
Buy-writing (the simultaneous purchase of 100 shares of stock and the sale of one call option) is the same strategy as covered call writing. Although this is my recommended strategy when it comes to teaching option rookies how to successfully learn to trade options, it's too risky for today's very volatile markets. It's important to understand how this strategy works because it provides an opportunity to understand how to reduce losses in a down market, while providing excellent income possibilities in neutral or rising markets. It also has a good chance to provide (unfortunately) ample opportunity to test your risk management skills. Thus, I do not recommend this strategy for trading – but it's still a good idea to understand how it works.
Today, I recommend option strategies that are similar to writing covered calls, but which provide much more protection against loss in a bear market. Those include: collars, credit spreads, iron condors, and double diagonals.