Technicals are important but not our only considerations when making covered call writing decisions, says Alan Ellman of TheBlueCollarInvestor.com.
Technical analysis is an integral part of our covered call writing decisions for both stock and option selections. It also impacts our exit strategy decisions. KORS has been a favorite of Blue Collar Investors for quite some time as a frequent member of our premium stock list. For the week of September 16 through 20, KORS was “bumped” from our Premium Watch List because of weakening technicals and BCI members were wondering whether to roll the option at expiration Friday. Here is a look at the bearish-leaning price chart that week:
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Since the price of this equity had been rising, most of our members were faced with the decision to either roll the option or allow assignment. The earnings were not due out until November 5. One of our BCI guidelines is to roll out rather than out-and-up if technicals are mixed. Here is a screenshot of an options chain I created when KORS was trading @ $74.30 and considering rolling out to the $72.50 strike:
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When feeding this information into The Ellman Calculator we generate a 1.7%, one-month return (21% annualized) with 2.4% protection of that profit. If those stats meet your goals, rolling out should be considered.
Next, let’s take a look at a chart from that date moving forward:
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Yellow field: After rolling out, the price holds in the mid-$70s and the 1.7%, one-month return is realized.
Pink field: Because earnings was due on November 5, we would allow assignment and have our shares sold @ $72.50.
Purple field: After a positive earnings surprise on November 5 (note the gap up in price), the chart technicals improved and a more bullish position could be taken as the stock price moved from the high $70s to the low $80s. On Friday, December 20, KORS was still a member of our premium watch list and trading close to $84.
Technicals are important but not our only considerations. We also view our overall market assessment and personal risk tolerance to make our final covered call writing decisions.
Summary
Technical analysis plays a vital role in our covered call writing decisions. We are more inclined to take a bullish stance when technicals are all confirming and bullish and a conservative approach when the technicals are mixed. There are no guarantees that this approach will work every time but it will absolutely throw the odds dramatically in our favor.
