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Covered Calls – The Hidden Risk for 2013 and Beyond

December 31, 2012 | About:
I’ve scaled way back on covered call writing lately. Why did I pretty much stop doing what has worked well for me for more than three decades? Let me explain.

Writing (selling) calls on shares you own is the simplest equation in option trading. Covered writing means only that you’d be willing to sell 100 shares, or some round multiple of 100, for a set price through a predetermined expiration date.

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Unless XYZ drops to below $9.80 before expiration the call seller would be better off than at trade inception. So what’s not to like?

In the crazy world of QE Infinity there is a real possibility of a market melt-up due simply to a major dollar devaluation.

A look at December’s action in the Japanese Yen and the Nikkei 225 Show how this could play out here at home. Japanese companies didn’t really become much more valuable in real terms. Their shares surged because the local currency collapsed.

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Japan’s newly reinstalled Prime Minister Shinzo Abe declared his intent to print unlimited yen. He intends to increase government borrowing to fund public works projects. That sounds very familiar to what were hearing now in America.

Will the value of the U.S. dollar drop drastically as we continue down this road? Absolutely. We all tend to forget where prices were years ago. Here’s a starling reminder for those too young to have lived through the past 40 years.

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The bulk of that inflation came without the printing presses running at full speed ahead. Washington has been lying about true inflation to keep the masses from revolting. At some point in the future America will see very high asset price increases. The only question remaining is the timing.

In that environment stocks should do extremely well on a nominal basis. They represent true earnings power rather than fiat-based (full faith and credit) pieces of paper. Selling covered calls now means betting you can predict when the coming big rise in share prices will occur.

Our market will ultimately skyrocket on the dollar becoming “worth less” rather than “worthless.” The last thing you would want in that environment is to have your real assets turned back into paper money. That’s exactly the risk you’re now taking when you sell call options.

Potential premium income you get from committing to sell at asset prices months in advance may pale next to any sudden price surges. You might very well get away with it for a few option cycles only to lose big when the ultimate flight out of paper money finally happens.

If you do not anticipate this possibility in advance it will probably be too late to fix. This unexpected risk is not being priced in right now because it appears to be such a black swan event.

I’m going with the old adage, “Failing to plan is planning to fail.”

This is not a good time to be selling calls.

About the author:

Dr. Paul Price
http://www.RealMoneyPro.com
http://www.TalkMarkets.com

Visit Dr. Paul Price's Website


Rating: 4.1/5 (9 votes)

Comments

lflaksin
Lflaksin premium member - 1 year ago
You can still lower you basis over time via front-month covered call selling or better yet by selling 2/3 ratios. Unless you believe in a sudden hyperinflationary scenario, you should be able roll up and out.
skyval
Skyval - 1 year ago
So will you do a long naked positions

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