Sunday, December 6, 2009

Overall Market Meter -- A Revised Covered Calls Investing Strategy

The "Overall Market Meter" on the right sidebar of this blog reflects the Covered Calls Advisor's current overall stock market outlook, which is currently "SLIGHTLY BULLISH." The meter also shows seven possible market sentiment indicators: Very Bullish, Bullish, Slightly Bullish, Neutral, Slightly Bearish, Bearish, and Very Bearish. To determine which indicator is most representative of this advisor's current outlook, a quantitative-based, multi-factor decision model is used. An explanation of the nine factors used to determine which one of the seven sentiment indicators is most representative of this advisor's "Current Overall Stock Market Outlook" will be the subject of another article on this blog in the near future.

The purpose of this article is to present the Covered Calls Advisor's preferred investing strategy for each of the seven possible indicators. First, let's consider this advisor's primary objective with covered calls investing, namely to "achieve market-beating returns." To accomplish this, an investing strategy should be designed to provide an opportunity to outperform the market for each of the seven market conditions. Fortunately, a well-defined, disciplined covered calls investing strategy provides an opportunity to achieve that goal by investing more aggressively in bull markets (by selling out-of-the-money covered calls), and more cautiously in bear markets (by selling in-the-money covered calls).

The chart below summarizes the Covered Calls Advisor's strategy for each of the seven market outlooks, and also provides a side-by-side comparison showing the original strategy and the revised strategy:

As described in a prior article (link), one of the great things about covered calls investing is that it provides us with three potential sources for profit: options income, dividend income, and capital appreciation. During recent months, this advisor has determined that a slightly more aggressive posture is desirable to become more fully exposed to the capital appreciation profit potential of covered calls. This is achieved through greater out-of-the-money exposure when initially establishing covered calls positions. Two revisions that enable this result are:
(1) The "New Strategy" shifts the moneyness of the strike prices toward a slightly greater out-of-the-money stance when establishing covered calls positions; and
(2) In bearish markets, by substituting some out-of-the-money positions on short (i.e. inverse) equities for what would normally have been in-the-money positions on long equities. For example, the chart demonstrates that when the "Overall Market Outlook" is "Bearish," the corresponding "New Strategy" will be to have 50% of the total portfolio value invested in covered calls that on-average are 1% In-the-Money using long underlying equity positions with the other 50% of the portfolio value invested in covered calls that on-average are 2% Out-of-the-Money using short (i.e. inverse) underlying equities.

If you have comments or questions related to the contents of this article, please feel free to submit them by clicking on the "comments" link below. If you prefer confidential communications, my email address is listed at the top-right sidebar of this blog site. Your comments are always welcomed.

Regards and Godspeed,


  1. i enjoy your blog a lot and it continues to help me as i learn more about options. 2 questions.

    will you actually SHORT the underlying or just use inverse etfs, like SH? and do you have a list of inverse etfs that you will use along with SH?

    reserve cash. do you have rules for how much cash sits on the sidelines depending on market conditions? have you ever used margin?

    thanks, mike

  2. Mike,

    Whenever my outlook changes to bearish, I would intend to buy inverse ETFs such as SH as the underlying equity. I have not yet identified other inverse ETF candidates, although I would definitely avoid any leveraged (double and triple) ones. Do you have any suggestions in this regard?

    Pertaining to your question regarding cash, I believe in being virtually fully invested at all times. Normally I am about 95% invested in covered calls and thus maintain only about 5% in cash. That 5% is useful to fund any roll-up transactions should that opportunity arise.

    I never use margin. Although its leverage could theoretically improve my overall results somewhat, I have found that being on margin causes me to experience a small amount of additional investing stress, which has the undesired effect of slightly distorting the calm, objective temperament that I believe is essential when making our investing decisions. Margin is okay for some investors, just not for me.

    Regards and best wishes in your investing,


  3. Jeff -

    I like the modifications that you're introducing to your model. I believe that the changes that you're making are in line with the general longer-term trends in the market, and will better take into consideration the capital appreciation opportunities that are available, along with the covered call premium income.

    You're providing all of us an extremely useful framework, Jeff. Keep up the great work!


  4. i havent considered 'inverse cc's'. if we have a significant correction i suppose i would consider it. i've been looking at calendar trades a lot (would do that probably on the spy, qqqq, iwm (maybe))

    this link might be useful in regard to inverse etfs:

    i wouldnt use margin either.


  5. Dick,

    Thanks for your comments and kind words of encouragement -- that is always appreciated.

    Best wishes,

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