During the obliteration day, I thought it will not be bad and just some sell-off. I was badly wrong. Why, because trump has the habit of pushing things beyond their limits and then walk back… Except this time, it is not clear whether Iran will cooperate with him on the walk back. Market cannot bleed 1% a day, but need to tank like 10% or 15% and VIX to spike to 40 or so.. to force Trump’s hand.
Time for protection.
Covered calls are protection. While markets are down my portfolio is up. The reason is that while stocks go up and down, the cash premiums stay put. The underlying stocks do go up and down but by rolling the calls, up or down as needed, one still has the same number of shares plus the cash from premiums, a little over 4% YTD.
The Captain
I do covered call but I would not call it as protection. Far from it.
For it to work as protection one needs to roll the calls, a process I learned about fairly recently. I just asked Google AI about it:
Question:
Conventional wisdom warns about getting the calls assigned but reality does not match theory. Except for dividend paying stocks there is little incentive to exercise the calls and by rolling the calls one avoids expired calls. But even if someone decides to do so, the probability that it will be our options that get assigned is low as they are picked at random by the system.
Google AI:
Your analysis touches on several core, practical, and often misunderstood, aspects of options trading. While conventional wisdom emphasizes the “risk” of assignment, the reality is that early assignment is generally sub-optimal for the option holder.
Here is a breakdown of the reality versus the theory based on your points:
1. “Little incentive to exercise early (except dividends)”
- The Reality: You are correct. It is rarely optimal to exercise an American call option before expiration because doing so forfeits the remaining time value (extrinsic value) of the option.
- The Exception: The primary driver of early assignment is indeed dividends. If the dividend amount is higher than the remaining time value of the call, it is financially logical for the holder to exercise, typically on the day before the ex-dividend date.
- Other Scenarios: Early assignment can also occur if the stock is extremely hard to borrow (high borrow rates) or if the option is extremely deep in-the-money (ITM) with almost zero time value remaining.
2. “Rolling the calls avoids expiration”
- The Reality: This is a standard, valid strategy for covered call sellers. By buying back the current option and selling a new one (rolling), you avoid assignment.
- The Caveat: Rolling only avoids immediate assignment. If the stock continues to run up, you may be forced to roll for a debit (paying to roll) or accept that the stock will eventually be called away.
3. “Probability of being assigned is low (random)”
- The Reality: While it is true that the Options Clearing Corporation (OCC) assigns options randomly among brokerage firms, the statement that the probability is low requires context.
- At-the-Money (ATM): An ATM call (stock price equals strike price) has roughly a 50% chance of being assigned at expiration.
- In-the-Money (ITM): If a call is deep ITM, the probability of assignment is, in fact, very high because the buyer has no reason not to exercise.
- “Random” vs. “Targeted”: It is random, but the pool of candidates for assignment is limited to those with short positions, and that risk increases significantly as expiration approaches, especially for ITM options.
Summary of Risks
While your perspective holds true for most scenarios, the “risk” of assignment is real, primarily functioning as an opportunity cost (losing out on further gains) rather than a direct capital loss, as you are paid the strike price for your shares.For actionable, low-risk management:
- Avoid Dividends: Close or roll calls before the ex-dividend date.
- Manage ITM: If your call is deep ITM, the probability of assignment is high, not low.
- Monitor “Hard to Borrow”: High borrow rates in stocks like NEGG or NKLA can trigger unexpected early assignment.
o o o o o o o o o o o o o o o o o o o o
Of course the probability of ITM options being called is real and the reason to keep the strike price close to the stock’s current price even if it means negative premiums but the delta at around 50% is in one’s favor. $2 in capital for each -$1 in premium.
If the option holder is likely to call it will be near the expiration date. It’s best to roll the call a couple of days sooner.
All the above assumes stocks held for the long haul.
The Captain
I have been doing options for 15 years; When you want to buy protection it is not covered call; If you sell naked put, you will not call that as protection; Covered call is nothing but naked put in risk and reward.
If you want to believe it is protection, I am not going to argue. You have a view and only experience can shape it.
Fair enough! Would you define “protection” for me. Maybe we use the term differently. Thanks.
The Captain
Here is an example of my covered call on WFC… At the time of writing $80 seems like decent downside protection, stock was trading around $93, here we are…
If the stock goes to $60, am I protected? No. A covered call is nothing but Naked put in risk and reward. When you write a covered a call, you are selling insurance not buying it.
PS: My reasons for writing covered call was not protection, but anticipating that the stock is stretched and it could pull back. I typically close the covered call, book the profit, when I think the stock has bottomed. This strategy is very different from buying a time-bound, an event specific protection strategy.
I can talk about it, but I want to clarify covered call on individual stock is not same as buying protection for the portfolio against market risk.
No, but how about Investopedia?
What Is a Covered Call?
A covered call is a sale of call options by a seller who owns shares in the underlying stock or other asset. The seller is creating an additional stream of income by collecting options premiums while continuing to hold onto the stock shares.
The max loss on a covered call strategy is the entire value of the stock, not including the call premium. So the only “protection” you have with a covered call strategy is a few percentage points of the total value. It would like saying you are protecting your $500,000 home with a policy that will only pay $20,000 in the case of a total loss.
By contrast:
What Is a Protective Put?
A protective put is a versatile risk-management strategy for investors wanting to protect their investments against potential stock or asset losses.
Insurance against risk is rarely if ever free.
I never sold a call deep ITM. I had to take a look to understand what you were talking about. Indeed, a deep ITM covered call looks like a put. I tried selling puts but stopped after some bad results. My calls tend to be near ATM the objective being collecting premiums. They are not individually protection but collectively they should outperform index investing.
Like I wrote above, I don’t see covered calls as insurance for individual stocks but I believe a well designed covered call strategy will outperform the typical portfolio or index fund. So far it has been working.
The Captain
I can agree with you on that point. Though, I would quibble on the “will” vs “may.”
This requires underlying stock moves sideways, or in a gentle uptrend. If the stock experiences any decline, you will incur severe losses. After it goes, if you continue to write calls, and the stock violently moves up, it will lock your losses. Which mean, when a stock is broken, you need to have discipline to accept the losses and close the position.
But note, this is not protection. Rather a hopium that you expect this strategy will work and you can outperform the index.
Here is another example.. Essentially, the covered call was written with 20% downside protection and if called will give 20% + dividend return. Look at it the stock is down 20% but the option is only down 60%, not covering the losses. Now, if you have written at-the-money whatever be the duration, your losses will be even more steep. You assume you could have rolled, but when a stock declines this much you cannot roll without coming down in the strike price. Essentially creating a new risk of getting whipsawed.
Again, what I posted is a partial view of the entire position, if the stock further declines or shows any signs of stability I will close the call, and go long. My original intent is to either make a 20% return or acquire the stock at lower cost basis. But the primary reason I shared this example is if the stock declines like 20%, 30%, (which are actually pretty common, unlike indexes) your strategy could incur losses in hurry. You can manage for a limited number of positions. But if you were to scale to 50, 60 positions with multiple accounts… it could be pretty time consuming and also leads to average returns.
That would be ideal but that is not the real world.
This is the problem I have solved. First of all, one needs the right stocks, stocks of companies that bounce back, like Tesla. Next one needs the best option selection tools. Around 2019 I created the Covered Call Selector as part of my Portfolio web app. It finds the best calls to sell across a number of hand picked stocks but it does not solve the volatility problem you point out. This led to the second tool, the Covered Call Roll Selector, finding the best options to replace the expiring ones.
With the Roll Selector I got to thinking about solving the volatility problems you point out. First of all, what was the risk of getting assigned at the worst time. Was it possible to ride the volatility up and down and not losing the stock?
Suppose you have a volatile stock that goes up and down like crazy but it is in a long term growth mode, for example Amazon. Does the volatility matter if you just keep the stock for years?
Now suppose you sell covered calls on AMZN and never get assigned. You still have the same capital gains plus the option premiums! The secret is not getting called. I decided to give it a try, documented at METaR. How about this volatility?
The Captain
There is no way you know for sure it is going to bounce back. If it didn’t the model will fail. When a stock bounces back, if you stretch the timeframe then it is moving in sideways…
I have lived through multiple drawdowns. Hence I use deep in the money calls, so that some of the volatility is mitigated and I am okay with 20% to 25% return on the covered calls.
If you are hoping for not getting called, then you can as well sell naked calls, except that you may not want the runaway stock risk.
We had this discussion in the past. If it works for you great. If you have the ability run some backtests to see how well your strategy would have worked for 2000~2009 bear market, COVID drawdown, etc. That may help you to look for early warnings, and may give you additional tools like when to fold a position.
But remember in investing there is no edge, everything is ephemeral.
Lastly, going back to the original post, none of this is buying protection. 
People are so literal! Of course I don’t know the future, no one does, but that does not prevent me or anyone else from looking for the best candidates for the strategy. That’s what stock picking is all about. More about it below.
We are on opposite sides on volatility, I welcome it as it increases option prices, more income! Of course it has risks, like getting called at the wrong time. I’m not hoping, recognizing and mitigating risks is vital to successful investing.
We have totally divergent views about the call option market. You seem to look at it as insurance, I see it as a gambling casino. I’m not a gambler but find casinos fascinating. I visited some in several countries. Las Vegas (MGM Grand) was highly educational. They had little pamphlets about all the games with the advice not to play to win but to have fun. Good advice since all the games are rigged against the players. The only one that can be flipped against the house is Blackjack which is why they ban card counters. The casino model is the House rigged against the Players – the vigorish.
Why do people buy calls? In the hope of getting cheap stocks. Gambling! I’m the House and only sell calls rigged in my favor. To detect them you need a tool to filter out the best out hundreds of options in option chains. The Covered Call Selector optimizes for income.
But that’s only half the strategy, what to do as expiration approaches? In a sense this is even more important than selling the most profitable calls. This is where I break ranks with traditional covered call lore. I like the stocks I’m playing so I don’t want to sell them…
Aim to keep the strike price as close as possible to the stock’s current price.
Sometimes one even has to have negative income to protect capital gains. Any one trade in isolation is not issue, overall outcome is. Some gamblers win but the casino stays profitable! If no one ever won casinos would be broke as no one would play. In the link I provided SMCI had a huge capital loss but made up by even greater premium income. When the stock bottomed, I bought some more! 
One does not need to wait until expiration. Should the stock spike on unexpected news one can roll up and out immediately to capture the capital gains. The captured capital gains outpace the cost of the roll.
This is the job of the Covered Call Roll Selector, the tool that enables the break with the traditional covered call lore.
The above is a different way of looking at selling covered calls and it has worked nicely so far.
The Captain
