What is the Best Time to Sell Covered Calls?
What is the best time to sell anything? The answer is: when that “anything” is highly priced and is considered to be in high demand. Supply chases price. That is a basic law of economics that will never change. Thus, when considering selling anything that you own, always consider how well or not it is “in supply”. Once the price of anything that has a continuous demand reaches a level where that price begins to entice those who can readily supply it, the top of the price cycle is near. Thus, supply is the key to judging the top of any price cycle while demand is the key to judging the bottom of any price cycle.
Covered call writing is somewhat like selling a call option on real estate holdings! For example purposes only, mentally imagine replacing long (owned) stock with a house that is owned. Assume for our purposes the year is 2006, basically a fair representation of the top of this latest real estate “up” (in price/demand) cycle. Now allow for the potential fact that the house in question was bought in the mid 1990’s for $150,000 and was selling in the local area for more than $300,000 by 2006. Then assume the house owner is contacted by a Realtor who inquires if he/she would be interested in selling to his/her client a call option on that house.
The details include that the striking price of the call option is $320,000 and the length of the option contract is one year. His/her client will, immediately on the signing of the option contract, pay the house owner $10,000. (Using 20-20 hindsight in now 2010, one cannot sign fast enough! But, our example unfortunately dates back to 2006.).
In this example, the owner of the call option on the house can either exercise the contract (at any time during the life of the contract) or he/she can let it expire worthless. If exercised, the house owner would have received $320,000 (the exercise price of the contract) and he/she would have also kept the premium paid, the $10,000. In total, the gross sales price would have been $330,000. If not exercised, the house owner (the call option writer) would have kept the call option premium of $10,000 and would then be free to sell another call option on his/her house to anyone else who might offer such.
The above is a fair representation of the real world of real estate. Options contracts involving real estate pre-date the stock market version of the listed equity options contracts that began trading on options exchanges in 1973. However, our focus is on equity options, not real estate. In a similar way, the equity options market offers the same advantages as in the real estate example above.
The best time to sell covered calls is very much akin to that real estate example. The focus should be on timing the price cycle for the stock market as well as the human emotional cycle as it pertains to the stock market. The emotional period of the stock market should be felt to be in a state of euphoria. Demand for stocks should be heavy and across a wide spectrum of business sectors, while the financial press begins to write articles about how supply of stocks in general is beginning to abate. Most financial news at this time should be seen as written with a bullish bias. Stock market analysts should be writing about how much farther up in price that the stock market should be rising over the long term horizon.
This combination of both emotional highs as well as demand for stocks should set the table for high call options prices at additionally high striking price levels, that will then offer to the covered call writer very enticing option premiums that will be paid for his/her stock. In addition, the “Standard and Poors” short term trading oscillator should be recording a reading of plus 4 or higher. This reading, a free service, can be attained by a phone call to “Standard and Poors” at 1-212-438-3605. A plus 4 or higher reading indicates a stock market that is high price and demand as well as what is considered to be in a condition of “overbought” if not at the peak of euphoria. Covered calls sold at this point can be expected to be sold for good to excellent price premiums.
Any valid contract has the phrase “time is of the essence” either written on it or it is legally implied. Time is the key or trigger to any options contract for both the buyer of the contract as well as the seller. The covered call writer (seller) should focus on the time element involved as well as current pricing of the calls that are being considered to be sold.
The covered call writer should in all respects be prepared to allow for the fact that he/she can be “called away” at any time during the life of the contracts sold covered. Preparation for being called involves tax implications, as well as portfolio adjustments. The options world is very dynamic as well as chaotic at times, even more so than the stock market, as equity options are generally leveraged by a factor of up to 10 to 1 or more. Most call writers do not use leverage, though most can use leverage offered by their broker at a 2 to 1 margin level.
Selling of anything with value is done for a variety of reasons. Buying of anything of value for an investment is done for One reason and One reason alone—greed. Greed and euphoria go hand-in-hand. They are the catalysts to the top of any price cycle and they should always be taken advantage of if possible. Covered call writing on common stock is a very prudent form of investing, if not the best strategy over the long term as most stock options expire worthless and un-exercised. Every month of the year involves an expiration of stock options, opportunities galore previously discarded by the potential covered call writer who passed on those covered call sales. At the peak of the next up stock market cycle, consider covered call writing as a prudent way to enhance overall return via a very conservative approach to the current world of stock options.