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Tales of a Technician: The Case for Covered Calls NOW!

January 18, 2016

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Last update: August 2021

To every thing there is a season, and a time to every purpose under the heaven.

Ecclesiastes 3:1

Stock investors in search of superior risk-adjusted returns should embrace the covered call with vigor. It’s a strategy tailor made for the masses to deliver cash flow coupled with a dollop of downside protection. As outlined oh-so-meticulously in my recent newsletter covered calls dampen the volatility of portfolio returns which in-turn creates less emotion and ultimately, easier profits.

What? You haven’t read the newsletter yet? Do you not like happiness? Or is it enlightenment you shun? Neither one? Well, then click on the hyperlink above and bask in both.

Tales of a Technician: The Case for Covered Calls NOW!

One of the important takeaways was that covered calls underperform during raging bull markets while outperforming in every other market type: sideways, up a little, down a little, down a lot. To fully understand why we need only think about the structure of the trade. You buy 100 shares of stock and then sell a call option. By selling a call you are promising to sell your stock at a certain price in exchange for being paid a little bit of premium. The cash received provides both cash flow and some protection in case the stock drops.

BXM Chart

The promise to sell the stock caps our upside profit potential thereby delivering underperformance in times of extreme bullishness. The last few years serve as a perfect example. Feast your eyes on the following graphic which shows the performance of the S&P 500 (gold) versus a buy-write (long the S&P 500, short monthly covered calls) (gray). Notice how in 2013 and 2014 when the market was roaring higher the gold line soared while the gray line sputtered. That right there is the covered call underperforming.

But guess what happens after a long spurt of the covered call underperforming? The pendulum shifts and it begins to outperform. Why? Well, typically because the big run-up just experienced in stock prices is overdue for some mean reversion. In other words, the bull market is due for a breather, or, worse yet, death. In either case you’re much better off selling covered calls on your holdings than simply holding stock at that point.

Take a look at the S&P 500 and ask yourself which is more likely: stocks continue the torrid pace set over the past few years (see trendline) or they rise at a slower pace, travel sideways for a spell, or even retreat for a while.


My bet? The second group of outcomes. I think the bull is extremely unlikely to duplicate the last five year’s performance over the next five years. I know, it’s a lay-up, no duh, no brainer bet. We’ve already seen the pendulum begin to swing in 2015. I strongly suspect the outperformance gap between SPX and BXM (monthly covered calls on SPX) will continue to close in the years ahead. So if you’ve been tiring of limiting your upside by selling covered calls on something like SPY and are ready to give-up on the strategy – DON’T. It’s high time covered calls start to earn their keep. And to be fair, investors have seen the strategy finally start to pull its weight through much of 2015.

To be clear: there is no time like the present to begin selling covered calls on stocks in your portfolio. That’s if you concur with my previous comments, of course.

If you need an example, we’ve been tracking a monthly covered call in my trading lab (an hour of glory, fun, and profits delivered to your doorstep weekly) on QQQ. We purchased 100 shares on April 9th at $107.31 and sold slightly out-of-the-money covered calls each month. At the time of this writing (Dec 30th) QQQ is perched at $113.27 marking a $5.96 gain for shareholders (excluding dividends). That’s a 5.6% return – not too shabby.

By selling covered calls (8 in total from May to Dec), however, we scored another $5.38 per share along the way. Tack that on to the $5.96 gain and our total profit ex-dividends is $11.34. On 100 shares that’s a $1,134 gain on a $10,731 investment and translates into a 10.6% return.

With covered calls we doubled the performance of stock owners. Why the trouncing? Because the market was neutral. Like I said, the buy write has shed its underperforming ways and is ready to play catch-up.

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6 Replies to “Tales of a Technician: The Case for Covered Calls NOW!”

  1. DENNISJAMES says:

    Sounds good to me and I love the scripture reference.

  2. The stocks which I’m writing covered calls against are just being slaughtered during this major correction 🙁

    I chose fundamentally sound companies. Got downside protection with puts and the calls have nice returns. Gotta have guts to endure, I guess.

    (Love the first line sang by The Byrds)

  3. MattQuattrochi says:

    Good article, just started studying Covered calls so timing is perfect.
    Sorry though I didn’t see the link for your previous article

  4. FRANCISAMOO says:

    Great article and very educative. Thanks Tyler.

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