by James Thomas
Writing Covered Calls is an option trading strategy that has stood the test of time in providing shareholders with both a regular cash income and the same time a downside buffer.
However, one considerable risk that I see many amateurs taking is that they hold a stock over a company's earnings announcement.
Why is this risky you might be wondering?
Well all you need to do is to take a look at stocks in the lead up to their earnings announcements.
If investors believe that the numbers will be good, great or far better than expectations then they will bid the stock higher.
Though it can be great to be a stockholder during this lead up phase the 'risk' lies once the earnings announcement has been made, which can sometimes occur a couple of days either side of their scheduled date.
Have you ever seen a company's earnings come out and beat expectations only to see the stock then sell off?
This can be a real trap if you don't understand what is happening.
What is happening is investors who have made profits through the lead up phase to the earnings announcement are now taking their profits.
You might have heard of the saying, "Buy the rumor, sell the news"
This is exactly what happens during earnings, and a strong company will almost always bounce back quickly after profit taking.
The problem occurs when earnings numbers come in BELOW expectations, or if they come in WAY BELOW estimates.
At these times a virtual bloodbath can follow and quick downside losses of 30-50% or more can result.
As a covered call writer, your 3-6% premium for the month will do little to offset this.
I've experienced this first hand and as a result I now never hold stocks over earnings, EVER!
It's just not worth the risk. What I do is close out my positions a couple of days before the scheduled announcement, which often turns out to be the most profitable time to do so, then after the announcement comes out and the stock settles back down, I then re-enter the position if it still fits my covered call criteria.
Happy option trading and investing!
However, one considerable risk that I see many amateurs taking is that they hold a stock over a company's earnings announcement.
Why is this risky you might be wondering?
Well all you need to do is to take a look at stocks in the lead up to their earnings announcements.
If investors believe that the numbers will be good, great or far better than expectations then they will bid the stock higher.
Though it can be great to be a stockholder during this lead up phase the 'risk' lies once the earnings announcement has been made, which can sometimes occur a couple of days either side of their scheduled date.
Have you ever seen a company's earnings come out and beat expectations only to see the stock then sell off?
This can be a real trap if you don't understand what is happening.
What is happening is investors who have made profits through the lead up phase to the earnings announcement are now taking their profits.
You might have heard of the saying, "Buy the rumor, sell the news"
This is exactly what happens during earnings, and a strong company will almost always bounce back quickly after profit taking.
The problem occurs when earnings numbers come in BELOW expectations, or if they come in WAY BELOW estimates.
At these times a virtual bloodbath can follow and quick downside losses of 30-50% or more can result.
As a covered call writer, your 3-6% premium for the month will do little to offset this.
I've experienced this first hand and as a result I now never hold stocks over earnings, EVER!
It's just not worth the risk. What I do is close out my positions a couple of days before the scheduled announcement, which often turns out to be the most profitable time to do so, then after the announcement comes out and the stock settles back down, I then re-enter the position if it still fits my covered call criteria.
Happy option trading and investing!
About the Author
James Thomas is an avid options trader and also likes to write on a variety of niche topics online including the best wood stove pipe to use for your wood stove. Read his double wall stove pipe review and get the optimum performance out of your wood stove this winter.
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