Wednesday, December 1, 2010

Up 200 points – a time for covered calls?

A 10% annual income stream from covered calls should be one of your goals and one would think a market that is up 200 points provides that opportunity. I have profiled the potential for 10% income with stocks like IBM and other stocks. 

Today's market action compels me to look for covered calls. (Read about covered calls in my resources section if you are unfamiliar with this concept.) As a matter of fact anytime the market is up by a couple of percentage points I look for calls. 

Here's the problem with today's market, it is trading on news and not on fundamentals. The last few trading days the market was down on news and I have bought some stocks. Today the market is trading up on news and not fundamentals and I want to sell some calls. 

When a company's fundamentals improve significantly such as a new technological breakthrough, or improved efficiencies that yield to more profit or they paid down debt and are more solid the price will go up. This price increase is looking to the future. The folks who buy the stock expect it to go even high and that is your chance to write a call for increased income. 

Today's trading action seems to be in response to news about unemployment or the China PMI and a bunch of other factors that we "the ordinary investor" have no control over and barely understand. I can tell this because as I go through my portfolio and I look at the stocks with the biggest daily gain in percentage and I look for calls. I found basically none. I am not willing to risk losing my stocks for the paltry amount someone will pay me for a covered call. I'll wait. When I look for calls and find several that will pay me 2% in call premiums, I know that the buyers have conviction that these stocks will go up. 

For instance if your bought a company at $45 and today it is $48 and you can sell a call for $1.00 for the right to buy your stock for $50 within 90 days that is a good deal. You will get more than 2% in the $1.00 premium and if they take your stock you get a 10% capital gain. Plus, if you picked your stock using our guidelines, you will also get a dividend during those 90 days. 

When you look for calls and the premiums are measly, no conviction exists and you should pass just like I did today. 

Do not be discouraged. Each time the market is up, look for calls on your stocks. Learn as much as you can about covered calls as this is one of the key components of the income investors' tool kit. I write often about covered calls. 

Very Truly Yours,