How to Use Covered Calls in a Falling Market

Why Should You Consider Selling Covered Calls During a Bear Market?

It can be challenging for investors to ride out a bear market. In particular, those who are retired or close to retirement age are hurt the hardest. Bear markets can wipe out years of hard-earned profits. For retirees with limited time and resources, this can be catastrophic. It is difficult to foresee when and how severely a bear market will decline. However, you may safeguard your investment from a market downturn in a number of different ways. For instance, you could hedge your equity holdings by selling covered calls. So, there’s no need to worry about selling everything you own and living on cash only. 

Selling call options on a stock portfolio is a great way to boost income. This strategy can help you recover some of your investment losses during a market downturn. As a result, covered calls can be a source of income and protection against loss in a bear market. By combining it with put options, you can hedge against potentially catastrophic market swings. If you’re currently experiencing a bear market, use these principles to help you survive.

In a Down Market, You Should Only Sell Calls That Are in-the-money

Writing in-the-money calls is a sound strategy in any market, but it becomes much more so when prices are falling. A potential downside of writing in-the-money calls is missing out on potential capital gains from an increase in the stock price. Contrarily, you will have far more downside protection if you write a call with a strike price lower than the current share price. When compared to just writing the call at or out of the money, this strategy provides more security. We all know that when the markets are falling, extra safety measures must be taken.

Apple 11/18/2022 $135 in-the-money call provides greater downside protection,

An ITM call offers much better downside protection. The above chart shows the current price of Apple stock at $147.33 per share. The breakeven price of selling a $135 call on November 18, 2022, is $132.45. This hedge will safeguard your investment against a 10% drop from the current price of $147.33 while still allowing you to earn a profit of $255 after 27 days. In other words, the maximum possible return on investment in 27 days is 1.93% (or 25.1% annually).

Only Sell Covered Calls on Financially Strong Companies

Only invest in companies that rank highly in their industry and are not particularly vulnerable to the current economic climate. That’s why it’s crucial that your equity portfolio is made up of solid companies. These companies will rebound quickly after the bear market has ended.

A Protective Put is a Great Way to Safeguard Your Covered Calls

The combination of long-term protective puts and short-term covered calls can provide broader downside protection. Covered call premiums can be applied to the purchase of a protective put option in some situations. One of the benefits of a longer-term put is the potential for protection over a longer period of time, perhaps several months. In addition, it does a better job of protecting your investment than a short-term put. This is because the time value of a longer-term option declines at a much slower rate than the time value of a shorter-term option.

Protective puts should be added to your covered calls to help ensure that the loss is kept to a minimum.

Summary

In a bear market, safety is king. You want to protect your capital by minimizing your losses as much as possible. Using the covered call selling strategy and protective puts, you can keep making money from your portfolio and protect its value when the market is volatile. 

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