How to make money writing covered calls

How To Make Money Writing Covered Calls

To make money writing covered calls, you first have to understand what you're really doing from a larger perspective in the context of the stock market itself, not just the option market. Many investors are attracted by the high income yields available in theory, only to find in practice that they do not achieve such high returns, or in fact even lose money from this supposedly "safe" strategy.

It's been said that while covered call writing appears to offer the potential for high income yields, what the strategy really does is merely smooth out portfolio returns, at the expense of lowering the total net return. Those who claim this offer the following explanation: the big money is made in the stock market by staying fully invested and exposed to both all the downside risk and all the upside potential, and since stocks always go up in the long run, you'll reduce your long-term returns by selling covered calls because you'll miss out on the big gains from the times they do go up as your stocks get called away before you share in the gains. Although when stocks go down you will moderate the losses slightly by the income you receive from selling covered calls.

The fallacy in this argument lies in the assumption that, like buy-and-hold stock investors, covered call option writers always stay fully invested in the underlying stocks. Successful covered call writers, whose portfolio results dwarf the returns achieved by buy-and-holders, do nothing of the sort. They buy stocks only at the right time, and they know how to get out of losers or hedge them.

To make money writing covered calls, you should not only be careful about stock selection, but also about timing. Remember, with option trading timing isn't everything, it's the only thing! Timing is certainly more important than any strategy.

Select stocks that are either in obvious technical uptrends, or at least in a flat trading range pattern coupled with a strong fundamental business outlook for the company.

Time your entry by purchasing the stocks only after a pullback (short-term decline) in price! Yes, by being this patient you certainly will miss out on some stocks that run away from you for awhile. But that is the exception, not the rule. Most of the time by chasing stocks you're setting yourself up for disappointment, and increasing your risk. This includes chasing back into stocks that get called away. Let it go, and move on to a different stock for now.

Do not sell the covered call option at the same time as you purchase the stock! If you do so you are relying on the strategy itself to make you money. It will not. No strategy is so good that it can work with poor, or no, timing.

If you cannot make a good stock market trade in terms of timing your entry, you will indeed prove the skeptics correct as described above.

Covered call writing is by definition not solely an option trading strategy. It is a combination of both stock trading and option trading. This is the all-important context I alluded to earlier. Covered call writing will enhance your stock market returns if done properly. But it will limit them if done improperly.

If you are not comfortable timing the market then you should not be trading options at all. You'd do better to just buy and hold stocks. You cannot consistently make money writing covered calls without timing the market. But seriously it isn't all that difficult. It's just a four-step process to make money selling covered calls:

1. WAIT for a pullback in the stock price.

2. Buy the stock.

3. WAIT for the next rally in the stock price.

4. Sell your covered calls.

The difference in waiting for the pullback to get a lower buy price may seem small for each individual trade, but it all adds up to a big edge for you in the market if you do it consistently.

Similarly, the difference in waiting for the next rally to get a higher option price will add up for you. Yes, sometimes you will miss out on juicy option prices by waiting, because the stock will pull back again before you sell your calls, and of course the option premiums decay with time. But again, that is the exception -- most of the stocks you select are in uptrends or eventually will be, and you've reduced the odds of a pullback hurting you since you already waited for one before you bought the stock (step 1).

Most investors who don't make money writing covered calls, or who never achieve the covered call writing results they had hoped for, are failing simply because they consistently skip both steps 1 and 3!

But not you, because now you know how to win!

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