RIO: Use Covered Calls With Overbought Stocks


  • Half of the S&P 500 is either overbought or close to overbought on the weekly RSI charts.
  • Use the up days to sell slightly out-of-the-money covered calls to February or March to collect income, cut risk and game the Fed taper.
  • Put your specific questions about stocks you own in the comments, include cost basis and percentage of portfolio.

Retirement Income Options focuses on option selling ideas, i.e. cash-secured puts and covered calls, on our Plug & Play lists.

Make sure to read:

If you have other stocks or ETFs that you have a question about, please ask a question in the comments, including, cost basis, % of portfolio and other pertinent information. 

Overbought Markets

Just a taste of what’s going on still:

Top of the S&P 500 Overbought “Monthly” RSI

If you look closely, you’ll see that’s a “monthly” chart of RSI. There is a 100% correlation to 10% plus corrections when a stock hits overbought on the monthly chart, just like there is with the broader S&P 500 (SPY) (VOO). Usually the corrections are outright bear markets of 20% decline or greater. It’s rare an overbought monthly chart lasts longer than 3 months. That is, once a monthly overbought is hit, a correction starts within 90 days.

Let’s examine Tesla (TSLA) as an example: 

Let’s look at the current price action on Tesla using the shorter-term weekly chart:

This sort of price action is what normally happens. Even with Tesla, the king of meme stocks. 

What’s the takeaway? Trim your overbought stocks and/or sell covered calls,  especially when weekly and monthly are both overbought. 

A Covered Call Strategy For Market Tops

During market topping processes you want to slowly raise cash over 3-6 months. We have been doing that. 

Right now, at these extreme market valuations, in the face of Fed tightening, you need to decide if the cash level you are at matches you risk tolerance. If not, look at your holdings to find spots to trim or sell covered calls.

So, assess each position for size in your portfolio as a risk management technique. If you own too much of something, in most cases, any position over 4% of portfolio holdings needs to be looked at closely. If overbought, decide if you want to trim, sell covered calls or a little bit of both. Generally, I only trim if the stock is both overbought and overvalued for the year ahead. 

In the spots where you write covered calls, I think now is a good time to go just a little further out on duration. So, instead of 1-2 months, which is our typical duration, push out to 2-3 months. In other words, just round up to a little longer, than rounding down to a little shorter. 

Why? Because that gets right into the heart of the Fed taper. If we get a 2018 like move, volatility will continue to ramp up, but really pop in the second half of Q1 after earnings and deeper into the Fed tightening.

Most of your calls should just expire without getting your stocks called away. If they do get called away, that means you made a little extra and it was probably a good higher spot to trim. Win-win. 

Stocks To Look At Writing Covered Calls Now

Once again, the handy dandy TradingView scanner with stocks that are on the VSL, have been, or I’m just monitoring. 

And, that’s using long-term monthly charting. On the weekly charts there are dozens more. 

If you own any of those, here’s the step by step:

  1. Determine how much you want to own as a long-term core position that you’ll never trade. For me, that’s usually just the starter position, but on higher conviction stocks, up to 2% of my portfolio. In other words, in times like this, I’m trimming most things back to 2% or less of my portfolio. 
  2. Decide how much of what is left you want to write covered calls on. In general, if I own a 2% position of some stock, I’ll write against about half of it. 

Here’s an example. I love Ford (F). I think they’re going to the moon in the next several years. But, I want to game the market a bit with smart risk management. 

First thing I do, is get down to 2% position if I’m above. Then, I’m writing $23 March calls for about a buck. That’s over 10% above the 52 week high on the strike, plus I’m collecting 5%+ in cash now with an annualized return of about 20%. 

But wait, there’s more. Between now and then, there will be some volatility. I’m also going to set an order to sell Ford $20 puts (about the current price) with a GTC premium of $4 (about $2 higher than today). 

If the shares rise past $23 by March and I’m called away, I have collected premiums and simply buy more shares down the road as I see what is happening come February and March. 

If the shares fall below $20, I probably get shares put to me with a net cost of $16, but, I also collected the buck on the calls too, so even more defrayment of my costs. 

That’s how my mind thinks. It seems to work out. The hard part is having the plan in your head, or on paper, or in a Google Doc, or on sticky notes all over your desk… and then following along with it. 

Disclosure: I/we have a beneficial long position in the shares of f either through stock ownership, options, or other derivatives.