I received a fantastic question regarding covered calls in the clubhouse this week. Since it’s something that I suspect many traders ask, I’m dedicating this week’s blog to answering it.

The Question

I’m confused on the timing of entering a covered call in a bull market. The graph that is shown says to enter the covered call at resistance. I guess my question is when to enter a covered call. Is it enter at resistance and buy back the call at support?

The Answer

There are two parts to a covered call position. First, you buy 100 shares of stock, and then you sell one call option. Sometimes when coaches are referring to a “covered call,” they’re discussing the entire position. Other times, they might be just referring to the short call portion of the trade. It’s crucial when you’re listening to someone teach that you know which one it is.

This is likely part of the reason for the confusion. The graphic you’re referring to discusses just the short call piece of the trade. Some traders buy stock and sell a call immediately. This is how I would start with trading covered calls because it doesn’t require you to perfectly time the entry on both sides of the trade. However, others may decide to buy a stock at support and then wait until it rises toward resistance before adding the short call.

The first benefit is your profit potential starts unlimited. It’s only when the stock is reaching a ceiling, and thus less likely to continue powering higher, that you sell the call. Remember, selling the call caps your profit because it obligates you to sell the stock.

Admittedly, legging into the position like this carries more risk. What if you buy stock and it immediately falls? In that case, you’d have to scramble to sell a call option for less premium than was initially available.

Let’s catalog the differences between both entry tactics:

Enter both sides of covered call simultaneously

Pro: No risk of the stock dropping before you can enter the short call

Con: No potential additional gain if you legged-in at the optimal times (long stock at support, short call at resistance)

Less Skill Required

Leg-in to the Covered Call

Pro: More profit potential if the stock rises after you purchase it

Con: More loss potential if the stock falls after purchase, but before you can enter the short call.

More Skill Required

The next part of the question referred to the management of the short call. If you’re selling calls at resistance, can you repurchase them once the stock has returned to support?

Sure. In doing so, you are returning your position from a “covered call” to long stock. This is a legitimate technique with its pros and cons. It’s certainly a more active way to manage the position. Starting out, I think it’s easier to sell calls and ride until you’ve captured the majority of the profit. Get comfortable with that, and then you can explore being more proactive in optimizing your entries and exit based on market conditions.

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