When I was writing covered calls month after month, nothing gave me more pleasure than to see the stock soar, making it extremely likely that I'd be assigned an exercise notice when expiration day arrived. It was always a pleasure to part with my shares because I earned the maximum possible profit from the trade.
When trading a position with limited profit potential, earning those profits is something to celebrate.
But not everyone thinks that way. I frequently read the laments of traders who were not satisfied with those gains. Trying to earn more than the maximum for the trade, once the call moved into the money, they bought back that call, hoping to see a continued rise in the stock price. And sometimes the wish came true.
But just as too many investors buy tops and sell bottoms, too often the stock reversed direction, and the sure profit turned into a loss.
Why would anyone do that? It's understandable. For some people making a profit is not good enough. They want to sell at THE TOP and take the most possible cash out of each trade.
If that's you, I can recommend a solution. It's almost guaranteed to keep you from risking your hard-earned profits in an attempt to eke out just a bit more.
Instead of writing the covered call, sell the equivalent put (secured by enough cash to buy stock if assigned an exercise notice). To be certain there is no misunderstanding – this is the put with the same strike price and expiration date as the call being written in the covered call play.
As previously discussed, the covered call and naked put are equivalent positions and when expiration arrives, the profit or loss from each trade is roughly the same . Any difference may come from commissions or an option being mis-priced by a couple of pennies.
This time, when the stock rallies, the investor's position is short the put – and that put steadily decreases in price. As it moves towards zero, the investor is pleased and there's no reason to buy back that put to sell another. Somehow the picture looks different when selling the put than when owning the covered call.
Yet the trades are equivalent. If you are someone who has trouble keeping your mitts off a winning covered call trade, consider writing the puts instead. Human nature makes it a pleasant experience to see the stock rise in value when you are short the put even if you would be unsatisfied when writing the covered call.
Any edge is good when trading and if this psychological edge would help you, then do it.
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