I have some stock positions that are underwater due to the market crash. I’ve been using short calls to help reduce volatility and cash flow while waiting for recovery. In selecting strikes, I’ve been reminded of key tradeoffs when engaging in this strategy. Since many of us are in the same boat, I want to provide some insights for today’s post.

Let’s use IWM for our case study. It fell from $170 to $95 (-44%!) before rebounding to its current perch of $107. Let’s assume you are long from much higher prices.

Balance

You’ll recall that any premium received from selling calls acts as a buffer to offset losses in the stock. This is the protection part of a covered call. Said premium also provides potential cash flow or income. Those are the pros or incentives for writing calls against your stock position.

The catch, however, is that you obligate yourself to sell your stock at a set price. In doing so, you limit your profit potential. And now that IWM is miles below our cost basis, we don’t want to cap our upside too quickly. Getting smacked on the way down and then locked out of participating on the way back up would be ultimate torture.

Thus, we have to balance our desire for protection/cash flow by taking part in recovery. Here are a few things to consider.

Ratio Covered Calls

The traditional covered call involves selling one call for every 100 shares owned. Instead, what if we sold one call for every 150 or 200 shares owned? Then part of our position would be limited, but the rest would have unlimited profit potential. Consider it a compromise. That way, if IWM is lucky enough to score a quick resurrection, we aren’t cut off from the upside too quickly.

Bear Call Spreads

Another interesting idea for only partially limiting gains is to sell a bear call spread instead of a single call. For example, with IWM @ $107, I might be considering selling a 30-delta May $117 call for $2.90. But just in case we skyrocket, I could also buy the May $125 call for 90 cents as well. Essentially, I’m selling a May $117/$125 bear call for $2 credit. I’m capped from participating in profits on the stock at $117, but my gains reopen at $125 and above.

I’ve turned a limited reward play back into an unlimited reward one. All for just giving up 90 cents of the $2.90 credit. Might be worth it.

Pushing OTM

The final idea is to simply sell a far enough OTM call that you’re satisfied with the potential profit. That way, if the stock zips to the moon, you won’t be overly disappointed that you didn’t fully participate. For example, with IWM at $107, maybe I’d be tickled pink if I could just get back to $120 and recoup $13 of the loss over the next month. In that case, I’d sell the May $120 call for $1.80. It has a delta of 22, so it’s further OTM that we usually go.

As with all things in trading, there isn’t a correct choice. You have to weigh the pros and cons and settle on what you believe strikes the right balance.

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