Selling covered calls is a simple and ¨not so simple"option trading concept which
option traders often begin with. It attracts people because of the appearance of juicy option premiums and yet often befuddles those who mistakenly believe it is an effortless way to gather ¨free" money.
So, I have compiled a simple list of reasons which causes failure for those who
try to earn regular income from the practice of selling covered calls.
- Taking profits before your position is closed. Option premiums may be hundreds of dollars falling into your account with the click of a few buttons. Resist the temptation to ¨count your chickens before they hatch¨ by waiting until your covered call position is closed or assigned before you consider the profit or loss to be realized. The Market is constantly changing. While this volatility is the best friend of an option trader, we must ALWAYS use patience and wait until positions are closed before we consider the gain/loss as REAL.
- Selling covered calls on an underlying asset that is about to go through a reverse split. Don´t sell covered calls on underlying equities that you do not fully understand. A surprise, merger, a negative earnings report, or a shocking news report can cause an unexpected loss in your covered call position. Do your due diligence and research the companies before you bet your hard earning money on a covered call position.
- Not choosing the most profitable strike price at which to sell the covered call at. Choosing strike prices is an art in my humble opinion. There are those who calculate complicated formulas to determine which strike price at which to sell a covered call at. However, I prefer the tried and true method of relying on many years of market experience.....reading tape...as they say.
- Choosing low quality underlying equities upon which to sell covered calls. Although, people can and do, sell covered calls on lower quality stock, it is inherently more risky to do so. Risk can lure in option traders with juicy high option premiums. But it can be very painful to your wallet to pour good quality money into a low quality equity position just for a very temporary boost in option premium. KNOW your underlying assets....and choose wisely.
- Using margin debt to finance the selling of covered calls. The stock market can be volatile, and using debt to finance your covered call option trades can be tempting, and can sometimes be profitable. However, any usage of leverage (debt) must be done wisely and with the understanding of risk, reward and interest rates. Not all investors have the temperament to manage debt wisely. Those who have a ¨gambler´s mindset may not want to even entertain the idea of using debt to ¨play¨ options with. Debt is a great tool in the hand of a master, but a deadly weapon in the hand of a fool.
Well, friends, that´s enough caution and warning for a beautiful Sunday afternoon. Be blessed in your investing and trading.
Peace,
Carla
