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Options Theory: How to Manage Covered Calls in Bull Markets

January 21, 2021

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The more decisions you have to make when managing a trade, the more opportunity for emotions to enter the equation. And that, ultimately, leads to more mistakes.

This is one reason why it’s so much easier to hold stock positions in a bull market than strategies like naked puts and covered calls. For example, I purchased the S&P 500 (via SPLG) last March for a long-term position. With dividends, I’m up nearly 40%. And do you know the best part? I haven’t had to make any additional decisions since then. No micromanagement, no profit-taking and redeployment of capital, no nothing.

It was a single decision that keeps giving and giving. And, I daresay it will continue to do so for years and decades on end. When I’m a great grandpa with a beard to my belly, I shall gather my posterity ’round me and tell the great tale of the 2020 pandemic and how I was able to purchase a basket of the best 500 companies on the planet at a steep discount.

Now, compare that to a covered call over the same time frame. Almost every month since April, I’ve had to roll up and out to maintain exposure. Is it a pain? Of course. And, here’s the key point. It extracts a greater emotional toll than long stock. It requires greater discipline to keep the trade going.

If there’s one thing I’ve learned, it’s that you MUST learn how to roll calls or redeploy capital after assignment if you’re trying to maintain a long-term position.

I’ve heard from multiple traders saying how they used to have covered calls on a stock, but they were assigned and never returned to the well. Meanwhile, the stock kept trending and building profits for those still owning it.

I’ve relearned a few best practices for managing cash flow trades during this bull market. Here are a few of my favorite ones.

Rolling with Cov Calls

If I decide that I want to own 100 shares of a stock as a core position in my portfolio, then I won’t allow assignment. Instead, I roll the calls up in strike or out in time (or both) to reload the extrinsic value and reopen my profit potential.

In situations where the stock rises to my call strike early in the month, I’ll roll up early – even if there’s still a bunch of time value. In situations like that, I judge participating in future upside for the stock as more important than milking the extrinsic value.

The same principle applies to naked puts. To reload your profit potential, you have to either sell more, higher strike puts after the stock has risen in value, or roll up your existing puts.

In bull markets, maintaining exposure is far more important than waiting for a perfect entry.

Ratio Covered Calls

Instead of fully capping your gains, how about selling 1 call for every 150 or 200 shares you own? That way, a portion of your position maintains its unlimited profit potential.

Covered Strangle

Another idea I use frequently is to add naked puts to my covered call position. Say I buy a stock at $100 and sell the $105 call option. The stock quickly rises to the $105 call, and I’m concerned about capping my gains. So, I add a short $100 put to the position.

I view short calls and short puts as an easy add-on to long stock.

I’m sure there are other worthy management tactics to embrace a bull market better, but these are the ones I use the most.

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