Understanding the Cycles

Before entering into a stock position in order to write a covered call, it is important to understand the overall, individual and current cycles of the stock. The bottom line is that stocks go up, down and sometimes trend sideways. Before you invest it is important to understand and take advantage of the current stock cycle.

In relation to writing covered calls, you want to ensure the stock is an upward moving or sideways moving trend and that it meets the buying low rule for covered calls. (you want to make sure the stock price is 25% or below of its current cycle.) To identify the overall trend, look at a one-year chart and draw trend-lines. Trend-lines are simply a way to visually detail the overall price movement of the stock. For an up-trending stock, start by drawing the bottom line touching the average low points. For a down-trending stock, connect the tops first.

Next, draw a parallel line, on the top for the up-trend and the bottom for the down trend. This will give you the price channel. Do this for the overall trend, typically a year, individual cycles throughout the year, which can vary-time-wise, and the current, which will be the most recent cycle. You next want to divide your channel into quadrants so you can identify when the stock is at 25% and 75% of the price in the cycle.

Before you can enter a new position and sell a call, the stock must be at the 25% or lower level. This measure is used in order to provide the benefit of riding the stock up, resulting in a potential call out at the end of the month. Additionally, knowing the stock's placement in the current cycle will be important for additional management and defensive techniques I will describe later.