Repairing a Covered Call
Mark, First I'd like to thank you for this great column. A
couple of questions regarding this:

At what point (or % decline) would you start buying back your calls if the stock was dropping? Is there such an order we can place that will protect us from our stock plummeting?


Hello Brian,

Good question.

In general terms, I don't have a  specific point at which I take action.  But, if I no longer want to own the stock - perhaps because of its poor performance (technical analysis)), or because I no longer believe the company's future is so bright (fundamental analysis) then it's time to get out of the position and cut my losses.

I recognize that for others, a stop-loss order works best.  Some market gurus recommend that traders or investors unload a losing position if the price drops by x percentage points ( x is generally between 8 - 10%).  If you want to follow that path, there is no reason why you shouldn't.  I prefer to go on a case by case basis.

But, regardless of how you decide it's time to get out of the trade, you can enter orders to close the covered call position in the event your target sell point is reached.  There are two alternatives, and not all brokers allow both.  Find out which one your broker allows.

1) Establish a stop-loss price for the stock.  If the stock hits that price, have a contingency order in place that automatically enters a market order to sell the stock.  As soon thereafter as possible (simultaneously, if you can) enter a market order to close (buy back) the call option you sold earlier.

2) If your broker insists you buy the call before selling the stock, then, enter a contingency order to buy the call option at the market, if and only if the stock trades at, or below, the stop-loss point.  Then, simultaneously (if possible) enter a market order to sell the stock.

Either of these contingency orders (good 'til canceled) will allow you to get out of your losing position.  But please remember - if you enter these orders with your broker, you must remember to cancel those orders if you sell, or change your position.