Option Investor
Market Updates

Managing your covered call

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Last week I felt that technology investors/traders might want to sell some volatility in technology stocks by writing some covered calls on stocks they were holding long. One fellow trader is a little worried that he/she may lose his/her stock as the point and figure chart gave a double top buy signal. I'm not sure where the subscriber wrote the covered calls, but traders that did do this should be looking pretty good right now. Let's take a look at Broadcom (NASDAQ:BRCM) and try to use this as an example of what to be looking for in other stocks that subscribers may have sold some covered calls on for April expiration this Friday.

Broadcom Chart - 60-minute interval

A trader that was writing covered calls on shares of BRCM late last week when the stock was trading above $32 and our 61.8% retracement bracket is looking pretty good. Call premiums were high late last week and a good time to be selling that volatility. One thing I like to do is try and analyze the stock chart on where I think a stock might settle out come option expiration. The above chart gives hint that the 50% retracement level at $29.94 would be a nice place as it relates to our retracement bracket. Once I make this observation, I can perhaps test it by looking at where the bulk of the open interest is. If open interest is sizable at the $30 strike, then I get the feeling that there may have been some heavy call writing at that level. An institution that wrote a lot of calls at $30 may not want to see the stock get called away if they think things are improving in the months ahead. Sometimes, this is what can cause excessive market volatility ahead of option expiration. If I've written covered calls on 200,000 shares (thinking like an institution) I might try and get the stock under the strike that I wrote to keep from getting the stock called away. Market makers will do this also on inventories that they hold. Those that built inventories from $20 to $25 may have been more than willing to sell the $30's for $8, keep the premium, work down their cost basis and not build further positions above the $30 level for the remainder of the week.

Open Interest

After I make my observation from the above chart, I then turn to the call option and begin testing my "theory." Here I see that the April 30 Calls (RCQDF) have 17,620 open interest and indeed represent the highest open interest for April expiration. (Please believe me, I'm not making this up, I just did this.) I also see that the April 35 Calls (RCQDG) have the next highest open interest at 10,409. If I split the difference between the two, I can see how a closing price of $32.50 would have both the $30's and $35's in a bit of a predicament. An institution could actually come into the $30's and buy back their covered calls for a profit and still save their position if they don't feel the stock would close below $30. I'll set up these scenarios and monitor them closely for positions I'm long or short. If you'll do this too with stocks you're currently trading or looking to trade, you'll be one step ahead of the trader that just knows how to click his/her mouse buttons.

Jeff Bailey
Senior Market Technician

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