You're on fire this week Mike with these high value posts!
I was just wondering since we are on the topic of the risks with selling CC how would your strategy change/adapt in the following situation. Let's say you have bought 100 shares in company X after checking valuations and the company has passed all your filters, and the option income provides a good risk/reward. You buy the shares and sell the CC but during the life of the option the price tanks. Maybe it's due to some surprise event, and it drops fast enough that you are not able to effectively roll out the call. The CC expires worthless but you are down a significant amount, let's say the stock has dropped 15%, while you are better off for having sold the call, you are still underwater.
So here is the question, what would you do in terms of the CC strategy at this point? You could sell another CC but the strike price will be below your entry price, hence if the shares are called away you will be selling at a loss. I understand the circumstances will dictate what to do, you would need to reevaluate the company and see if it's worth hanging onto the shares or not. But if you do decide to keep them, would continue to sell calls on it?
So, that is a great scenario you are describing - every CC writer hits this eventually.
Here's how i approach this:
First, check the thesis, not the trade. That 15% drop is either temporary headline risk or deteriorating fundamentals. If the business case is broken, I just exit and move on. Covered calls enhance income, but they def don't fix bad stocks
Then, recalculating your real cost basis matters. Because your $27 entry isn't really $27 anymore after collecting premiums and dividends, maybe your net basis is $26.65. That's where you start losing money.
Then we'd have to pick a repair strategy:
1. Pause - skip a cycle, just collect dividends while volatility settles
2. Sell calls at/above net basis - target strikes around the real breakeven, accept lower premiums
3. Go longer/higher - 90-180 day calls further OTM for less assignment risk
4. Add repair puts - sell CSPs lower to collect extra premium or average down
What I never do is selling calls below the net basis unless I'm consciously deciding to exit at a loss. Dividend cuts, credit downgrades, or strikes sliding lower each quarter means it's time to exit. The goal here is converting drawdown into monthly "micro pay raises" until you're back to breakeven. Sometimes the best move is just collecting dividends while the dust settles - imho works better than trying to force bad trades on wounded positions.
Amazing! On the surface, seems like one of the more compelling options for tax advantaged income in a brokerage account beyond MLPs or simple qualified dividends, but I also realize they’re new and relatively untested.
Thanks, JP! I'm actually working on a piece about this right now (tax claims, comparing their methodology to DIY, fee analysis, etc). Should have it out next week or so
Thanks Mike. Another enjoyable read.
Appreciate it, Craig!
You're on fire this week Mike with these high value posts!
I was just wondering since we are on the topic of the risks with selling CC how would your strategy change/adapt in the following situation. Let's say you have bought 100 shares in company X after checking valuations and the company has passed all your filters, and the option income provides a good risk/reward. You buy the shares and sell the CC but during the life of the option the price tanks. Maybe it's due to some surprise event, and it drops fast enough that you are not able to effectively roll out the call. The CC expires worthless but you are down a significant amount, let's say the stock has dropped 15%, while you are better off for having sold the call, you are still underwater.
So here is the question, what would you do in terms of the CC strategy at this point? You could sell another CC but the strike price will be below your entry price, hence if the shares are called away you will be selling at a loss. I understand the circumstances will dictate what to do, you would need to reevaluate the company and see if it's worth hanging onto the shares or not. But if you do decide to keep them, would continue to sell calls on it?
Thanks Omar! I'm happy to hear that it clicks!
So, that is a great scenario you are describing - every CC writer hits this eventually.
Here's how i approach this:
First, check the thesis, not the trade. That 15% drop is either temporary headline risk or deteriorating fundamentals. If the business case is broken, I just exit and move on. Covered calls enhance income, but they def don't fix bad stocks
Then, recalculating your real cost basis matters. Because your $27 entry isn't really $27 anymore after collecting premiums and dividends, maybe your net basis is $26.65. That's where you start losing money.
Then we'd have to pick a repair strategy:
1. Pause - skip a cycle, just collect dividends while volatility settles
2. Sell calls at/above net basis - target strikes around the real breakeven, accept lower premiums
3. Go longer/higher - 90-180 day calls further OTM for less assignment risk
4. Add repair puts - sell CSPs lower to collect extra premium or average down
What I never do is selling calls below the net basis unless I'm consciously deciding to exit at a loss. Dividend cuts, credit downgrades, or strikes sliding lower each quarter means it's time to exit. The goal here is converting drawdown into monthly "micro pay raises" until you're back to breakeven. Sometimes the best move is just collecting dividends while the dust settles - imho works better than trying to force bad trades on wounded positions.
Great info! Thanks🙏🏻
Thanks, Anna!
Great write up (per usual)!
Have you looked into the Neos covered option ETFs (SPYI, QQQI)? Specifically, the tax advantages they are touting have piqued my interest.
Amazing! On the surface, seems like one of the more compelling options for tax advantaged income in a brokerage account beyond MLPs or simple qualified dividends, but I also realize they’re new and relatively untested.
Will look forward to reading!
Thanks, JP! I'm actually working on a piece about this right now (tax claims, comparing their methodology to DIY, fee analysis, etc). Should have it out next week or so