Question on writing covered calls

Question:
Sir you always buy stocks making high on some time frames and essentially avoid stock making lows. However Tata Steel was making new lows every day ..so my query why you chose this ? Same query in SBIN...Please reply.

Amit

Answer

For delivery based swing or investment trades, it makes sense to buy stocks making new highs or say giving a breakout over 3-6 months trading range. The reason is stock will go up fast as smart money is buying and it is easier to go with flow and get better returns. These trades are also safe as the trend is up and you are trading in the direction of the trend.

In covered call writing, I am writing an at-the-money call and also buying the stock (cash/ delivery). This strategy will be profitable in following situations:

- stock making new highs

- stocks trading in a range

- stocks which have corrected a lot and have limited downside

- stocks which are mildly bullish.

My biggest risk is the downside risk. This can be minimized by:

- trading in stocks with limited downside potential (check with monthly charts)

- investing in excellent companies

- having a long term outlook on the stock (delivery)

- willingness to repeat strategy over several months

SBIN, TATASTEEL meet the criteria fundamentally and technically (see monthly charts). Others are RELIANCE, ITC, ASIANPAINTS, HLL etc. But I am not sure if there are volumes in calls for these stocks.

Why not stocks making new highs? Simply because there are not many in this market today. But if there is a stock giving a breakout, one can repeat strategy here also.

Other factors in call writing:

- stock option should have good liquidity 

- high IV preferably 30% plus. 

The biggest problem in Indian markets is the poor volumes in stock options. As a result of this, call writing gets limited to a handful of stocks.

See today's volume in stock options - pathetic.