The market hasn’t found a bottom yet, and volatility is at crisis levels. The CBOE S&P 500 Volatility Index (VIX) is regularly above or around 70.
We have decided that an appropriate strategy for the near term is stepping back and selling covered calls against the long stock positions we are currently holding.
We took possession of Microsoft (NASDAQ:MSFT) common stock in early March for $175 per share, and we want to use the stock to generate income while we wait for the market to find a bottom.
If you, like us, have been holding this stock, the high implied volatility in the market makes this a perfect time to sell a covered call.
Looking to MSFT’s Future While we Collect
The volatility we have been experiencing in the market has made it extremely difficult to enter new short options positions. Both put writes and covered calls carry additional risks when volatility is high.
But higher implied volatility also increases option premiums. With higher premiums we can recoup many of our losses by selling calls against our long-stock positions.
If traders sell further out-of-the-money calls, they can collect large returns without having their stock positions called away, which is precisely what we want to do with MSFT.
We have been trading MSFT in the portfolio — in one form or another — for more than two years, and we have always been able to work it out of drawdowns like the one we are in now. We still like the position.
The company will launch a new Xbox when the holiday season rolls around. If that launch is successful and the market is starting to recover, it could act as a boon for the stock.
And as we are fond of reminding traders, MSFT is one of the few tech companies that pays a dividend. When the market does start to recover, that dividend will be incredibly important in this zero-interest-rate environment.
We feel comfortable holding on to the stock for the foreseeable future, but if we are going to keep MSFT in the portfolio, we need to start earning back some of the losses we incurred since we bought the stock.
MSFT is Ready for a Covered call
We’ve been waiting for two things to appear on MSFT’s chart — a support level and a support bounce — and it looks like we have them. Support at $135 has held for the past few days, and though the stock has been quite volatile, it was moving higher yesterday.
Daily Chart of Microsoft Corporation (MSFT) — Chart Source: TradingView
We originally purchased the stock for $175, so in order to prevent us having the stock called away for a loss, we won’t set a strike any lower than that.
Fortunately, as mentioned above, a far out-of-the-money covered call can still be profitable in this market. If you have been holding shares of MSFT, a covered call could be an excellent way to generate extra income as we push through March and on to April.
As always don’t commit to this position for too long. Picking an expiration in mid- or late April should provide plenty of premium.
InvestorPlace advisers John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of Strategic Trader.