Well, it's not that it is a bad strategy. In a bull phase it comes down to the issue that you have to be willing to lose the stock on a move like that.
< is it not a good strategy if you plan to be long a stock for any lenght of time?>
Because in a situation such as I described for an imaginary issue that has a sharp upward move there is a question whether one should, in effect, "chase it" by covering the call. What was happening to me was that often I was in the "mixed feelings" situation. I was fortunate to buy a stock that had a explosive upside move but unfortunate in the sense that I was not participating in the bulk of the move.
I was gathering dollar bills when I could have been gathering tens and twenties, so to speak. The reason why, I believe, it was not a good money management play for me was because I was not allowing myself the ability to let my profits run.
Here, you are taking what I presume are beaten down issues that may take time to recover so it may be considered a different situation. For me, I was using stocks that had a nice recent move so I was taking them in and selling the volatility. In that phase of the market the issues were (in hindsight) momentum plays so they were taken away. Covering the options usually was not a rational decision.
I was referring to that period of time when I was posting to Stu. I do not recall any stock in particular, but let us say that you purchased RMBS in your IRA early this past February after it moved from the 50s to the 70s. Writing the OTM call you probably would pick up a ton of premium. By March expiration the stock would have been over $450. In effect, the trade would be a very profitable scalp. From a risk/reward point of view, I do not know if it would have been the best play in retrospect.
Looking back on such a period, many stocks with high implied volatility present had momentum-based moves. |
