Using Stock Cycles For Covered Call Writing

As a Chartered Market Technician I spend considerable time exploring the quantitative side of stock and broader market cycles to find periods of statistical advantage. For investors it is often simply trying to maximize the returns from a longer term holding. I have found that there is considerable value in enhancing investment yields through periodically and passively implementing covered calls.

Key tenants to this methodology are the open acceptance that stocks do not just go up in a straight line, but rather go through cycles of overbought and oversold conditions. If that can be openly accepted, then it becomes about identifying a measuring technique to quantify that cycle.

To illustrate, I will use BCE shares. BCE has been in a decisive bull market from its 2008 low of $16.85 to its current test of multi-year highs. A disciplined and patient investor has been well rewarded with a material capital gain and a consistently lucrative dividend income stream. But when one looks deeper into the cycles, investors may see value to seeking to enhance that return.

On the table below I simply identified where the stock price was relative to its 52 week mean average. What is identified is that over the last 5 years BCE has had 7 intermediate swing highs that, on average, occurred when BCE was trading $5.00 above its 52 week mean price. Each of these 7 periods the stock proceeded to consolidate lower or sideways an average of 185 days (6 months).

If an investor was to believe that there is statistical merit to that observation, then selling covered calls on the stock when it has reached an overextend state would enhance the yield income on a stock with limited short term upside potential.

Last week on November 21st, BCE had a closing price at $54.24, which was $5.96 above its $48.28 52 week mean price. Referencing the 7 past cycles, this suggests that BCE may be close to the upside of its current rise and there may be increasing value in writing a covered call at these levels.

• At the time of writing (Nov 26, 2014), BCE is trading at $52.88
• May $54.00 covered call is bidding $1.05 (1.99% cash flow)
• May $56.00 covered call is bidding $0.50 (0.95% cash flow)

For an investor that owns BCE for the current 4.67% dividend income stream, selling a strategic covered call gives the potential to enhance that income to 5.50-6.50%. While there is no guarantee the stock cannot go higher and exceed the call strikes, an investor that looks at the probability associated with the rise may recognize it is far more probable that the stock consolidates after such a substantial rise. If a covered call was strategically written at each of these 7 prior peaks, the investor could have collected 5-15% addition income over the last 5 years.

Using options is an active strategy, that may involve having to sell the stock or buy back the option which makes the strategy more dynamic. But for an investor willing to be more active, the additional income may be worth the effort.