There was a post recently on reddit.com/r/babytheta where OP was lamenting that they seemed to always sell their covered calls at just the wrong time.
That's very common. I have done it (and continue to sometimes).
If we break this down, there are three times you'll sell a covered call at the wrong time:
- Underlying crashes. You sold a CC and then suddenly the underlying starts crashing. Would have been better to sell the underlying in that situation than a CC on it.
- Underlying moons. You sold a CC and then the next morning the premium is 500% higher than what you sold it for.
- Underlying trends up. You sold a CC and then the next morning the premium is 20% higher than what you sold it for.
Let's ignore "underlying crashes" and "underlying moons," especially the mooning event because that's very unpredictable and so can be thrown out of the discussion entirely. That just leaves the normal reason people get frustrated after selling a CC: the underlying ticks up and you find out you could have sold the CC for higher than what you did.
When the Underlying Trends Up
This is generally predictable, and in fact you did make a mistake. If you are wheeling, doing PMCC, reducing your cost basis, whatever, you need to understand your underlying.
Not everybody is big into Technical Analysis (TA) and that's totally fine, however for most underlyings a quick TA session can have a big impact on your profitability. I'll walk you through charting out what is going on with the underlying and it will be very clear WHY you generally sell a CC at exactly the wrong time.
Sell High, Buy Low
The classic mistake of course is to Sell Low, Buy High. That applies to options just as much as to stocks. Let's use $JPM as an example since I use it for PMCC. (I include screenshots below but you can view the entire chart with dates here.)
Now, let's say you own $JPM with a cost basis of $150. Per the chart, $JPM is currently at $152.24. So we can sell a CC at anything above $150, preferably above $152.24, and, for most, at strike of .3 delta or lower. I like to sell with a 30-45 DTE, but that (and the delta) is specific to your trading plan.
If we look at the option chain for May 14, we see a $160c strike .29 delta for an ask of $2.36 credit. If we wanted to sell the CC right now, we'd likely sell around a $2.27 credit.
Since the strike is OTM, that means that the $2.27 is pure extrinsic. We can also do a quick calculation of the premium rate, which is just $2.27 / $152.24 = 1.49%.
Going back to our chart, we'll draw a channel around the stock. This is not always accurate. You may chart something at the wrong timescale or just at a bad time and your chart is wrong. That's why not everybody is a fan. That said, again, I think it helps improve our "average case" even if it doesn't get us to the best case.
Per the chart, $JPM is currently trading inside a channel that has an uptrend. This does not mean that $JPM won't break out below or above the chart, go wonky, or whatever, but at least we can see a current pattern. And we can also see that TODAY that if we sell a CC, even if it's a green day, we would likely lose out on profit and likely be assigned on our underlying. Note that $JPM is at the bottom of the channel and is likely going to bounce back up. If we sold a CC today at $160 with an expiration of May 21, $JPM will be ABOVE $160 even at its low point on that day.
If we did want to sell a CC, probably best to sell a $160c Apr 9 or a $170c Apr 16 if we wanted to keep the underlying.
More importantly, we are selling a CC when $JPM is at its lowest in the channel. We will get the least amount of premium possible if we sell in the next week. Honestly, to maximize premium we would want to sell around Apr 27 because that's when it will hit the top of the channel (give or take several days).
We can also see that if we sell around Apr 27 that we could sell a $190c and that the value of the CC would plummet very quickly as $JPM began going down toward the bottom of the channel. We would also want to sell CC's as fast as possible Apr 27 and follow $JPM down to the bottom of the channel, watching the value of each sold CC plummet quickly, we BTC at 50%, and rinse-and-repeat.
Ideas
I'd love feedback, but to me this indicates that:
On the upswing:
- Set your ask above the market ask when selling a CC on an upswing. Let the market catch up to your ask while reducing your risk of assignment (your CC being executed).
- Sell at or below .3 delta.
On the downswing:
- Set your ask at market to ensure the CC is opened.
- Be more open to a higher delta on the downswing.
