Fight Trading Panic With Covered Calls

Options are an excellent tool for the difficult trading days we saw last week. Experienced options trading investors rarely sell into a panic because they know it will end and the market will once again value stocks fairly. Rather than selling stocks, these investors take some kind of protective action such as selling covered calls to capture time premium while the premiums are high. How To Handle A Market Meltdown The price of options rise during times of high uncertainty. This can be a good thing if you are a seller of premium (which covered call writers are). However, you probably don’t want to sell strikes below your break even point unless they are very short term. A better plan might be to lock in a few months of premium while anxiety is high. Let’s take two examples: An existing position where the stock has dropped below your break-even point, and a new position that you’d like to initiate during the market meltdown. Trading Idea 1 – Existing Position Let’s say you bought XYZ Corp at $100 a few weeks ago and sold a March 105 call option for $2 (so your break even is $98). Today, after uncertainty in the Middle East and Japan, you find the stock is now trading 15% lower at $85/share, and the Mar 105 call is trading for 10 cents. Let's say its Wednesday on expiration week. This is a good candidate for rolling down for the March cycle. You can buy back the Mar 105 call option for 10 cents and then sell a Mar 95 call option for maybe 50 cents. You get a net credit of 40 cents so your break even is now $97.60. You are at risk of having the stock rise by more than $10/share in the final days two of the March cycle and having it called away, but that seems unlikely (12% rise in two days). If it happens then you will receive $95 for a stock that you have a basis of $97.60 in. Bottom line, you could lose $2.60/share if called. Find more option analysis and trading ideas at Option Trading Strategies . On the other hand, if the stock stays below $95 by the March expiration then next Monday you can sell a new option for the April or May expiration. You may want to do the Apr 95s or May 95s, whichever one will give you at least $2.60/share in premium, so that your break even will be less than $95 and you will make something if the stock is called. You may not make a ton but we are talking about a market meltdown situation here, so making anything at all will be a win. Go to page two for Mike’s second approach to using covered calls during a large sell off.
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