Covered Call Writing With an Extra Kicker of Premium

The Markets at a Glance

On the surface, the market simply looks like it got cold feet about the economy from last week's job numbers, only to recover most of its composure with the inflation numbers this week showing that the war on inflation looks to be progressing enough for the Fed to lighten up on interest rates in September. The VIX chart has just about completely recovered from its recent spike, indicating that the pressure to purchase market puts has now subsided.

This hypersensitivity to economic data reflects the delicate balance that the Fed is currently dealing with between keeping rates high enough for long enough to dampen inflation while not keeping rates high for a long enough time to throw the economy into a recession. The markets had been giving the Fed the benefit of the doubt on achieving a "soft landing" up until last week's disappointing jobs numbers, when it got a significant case of the jitters. But now that the inflation numbers are coming down, investors are all but certain the Fed will lower rates in September.

In my opinion, however, the soft vs. hard landing scenario has not yet been resolved. So, while the market got a reprieve from the higher probability of seeing a rate cut next month, that news is now likely baked into prices, while anything but a soft landing on the economy is not. In other words, the market is pricing in more good news than bad, which in my opinion suggests a cautious stance should still be the primary one.

Under the surface, I read where it was institutions that sold last week but retail investors that largely propped things back up this week. Of those two groups, the odds of an overreaction tend to be higher with the retail investors. Also, a close national election will also expectedly hold the markets in suspension during the next couple of months.

Strategy talk: Covered Call Writing With an Extra Kicker of Premium

Implied volatility at around 16 on VIX is not providing option traders with the exceptional call premiums of a week ago. However, option premiums are still high enough to offer a respectable return mostly from the premium, even if little appreciation also occurs. And, if you don't limit yourself to straight 1:1 covered writes, you can enhance the premium received even more.

If you remain modestly bullish and believe that overreactions will continue to rule the day with regard to interest rate cuts and economic news then you can continue to do covered call writing, while adding an extra bear call spread on top.

Take Alphabet (GOOG) as an example. At 163.17 on Thursday's close, it is still 16% off its July peak. But it is being held back by SEC threats to break it apart. So, it is a favorite and a great value, though may continue to get a discount for a while.

A September covered write on GOOG using the 165 calls at 4.15 would return about 38.2% annualized on a full cash cost of $159.02 for 36 days.

But if you add a bear spread on that at the 170 and 175 strikes (sell 170 call/buy 175 call) for the same expiration, you pick up another 1.05 credit, lowering your cost on the covered write to around 158 and producing an annualized return of 44.6% if called away at 165 but still below 170. (Remember, however, that you are now adding in some upside risk.)

The point here is that if you are largely looking to get a return from option premium as opposed to stock appreciation, why constrain yourself with a simple 1:1 covered call write? You can even do these on a shorter duration expiration for a higher potential annualized return.

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