How to use covered calls as portfolio protection in volatile markets

The S&P 500 is on track for its worst month since March 2020, with the average stock in the index down about 20% from its 52-week high. Combine that with a volatility index above 30 and on track for its best month since November, and you have a very dangerous environment for your portfolio.

Fortunately, there are ways to use options to protect your holdings against declines, and one of the simplest strategies is also one of the most effective.

“When volatility is this high, there is a simple strategy that almost every option trader has at their disposal that provides downside protection and some income, and that is a covered call,” OptionsPlay chief strategist said on Wednesday. Tony Zhang on CNBC’s “Fast Money.” .”

“This is a strategy that requires you to hold at least 100 shares of a stock option or ETF, where you can write a call option against that stock, with that stock as collateral against the obligations of that call,” Zhang said. “What it does is force you to sell your shares at that specific strike price on or before the expiration date.”

This strategy risks losing future upside exposure on a given position, in exchange for income.

“This is [a strategy] that will reduce your cost base and provide some protection against loss [by way of] the premium you’re charging, and in this particular environment with such high volatility, you’re only going to be able to charge more premium,” Zhang said.

As Zhang points out, today’s heightened levels of volatility mean option premiums are higher across the board, but the sharp swings in technology and consumer stocks mean those areas of the market are where premiums can be charged the most. tall. For Zhang, one name stands out from the rest.

“If you look at Robinhood, a 30-day $12.5 strike [call option] – that’s a strike price 30% above the share price – will generate about 3.5% of the share value in just 30 days. That converts to about a 44% annual return on that covered call,” Zhang said.

Add Comment