Over two last week or so, I wrote two articles on covered calls:
My goal was to show you how you could use stocks as an asset to create a cashflow for yourself.
Then at the end of last week, I asked you if you read the articles to fill out this feedback form so I could find out what you liked, what you didn’t like and what you want me to write about next.
Over the weekend, I received a lot of great feedback and I’m going to be using it to improve those articles…
And to write a whole lot more tutorials to help you create an income for yourself with your trading.
But before I do that, I wanted to address one piece of feedback that scared me to my core.
Now, I want you to know that these surveys are anonymous, so I can’t see who submitted this.
But someone was submitting what sounded at first like a good piece of feedback.
But as I finished reading the sentence it scared me to my core.
What was it?
“Your explanation about selling covered calls help me understand why you can never lose money.“
First of all, thank you for the positive feedback.
But I want to reiterate: It is absolutely possible to lose money selling covered calls!
Yes, it is a relatively safe method of owning a stock and lowering your cost basis over time and even grabbing some outsized gains when you finally get called out.
But the stock market can — and will — throw everything at you.
And some of those situations can include a company going under… Or dropping lightning fast and never recovering.
I’ll give two quick examples.
Enron – Going to Zero
Do you remember Enron? In the early 2000s it had a financial scandal that ended with the company going bankrupt.
The stock traded as high as about $90 in August of 2000, after which the stock started dropping…
And dropping… and dropping. Till the company went to Zero.
Here’s the chart showing the slide over the course of 16 months:
I haven’t done the math, but with a stock that drops this far this fast, I don’t think even covered calls could save you.
I mean, the stock went from $90 to 12¢ in less than a year and a half.
AIG – Down For The Count
Enron is kind of an extreme example. Thankfully companies don’t go out of business every day.
But let’s look at another stock: AIG.
This insurance company skyrocketed during the 1990’s until it met the DotCom Bust.
At that point it dropped more than 50% over a period of 3 years.
But that’s not the worst part.
Leading up to the Great Financial Crisis of 2007/2008, it was trading at around $1450 per share.
But between June of 2007 and October of 2008, the stock plunged 96%!
The company still exists today — but 16 years later it still hasn’t recovered.
Again, I haven’t done the math on this one, but I’d find it hard to believe that covered calls could have saved you on this one either.
Not Once-In-A-Lifetime
This second scenario isn’t as rare as you might think.
Here are just a handful of stocks off the top of my head that crashed down dramatically.
Many of these crashed years ago, so you’ll have to look at a long-timeframe chart to see what I mean.
- TLRY
- NUS
- GME
- ZM
- MU – this one crashed back in 2000 and looks like it’s about to do the whole pop/crash all over again!
The Lesson
I don’t share these examples to scare you. Admittedly, they are extreme examples.
I just want you to be aware. There is no method in the market that guarantees success.
The market is all about putting the odds on your side.
And I do that by picking rock solid stocks.
And using income techniques like covered calls to bring in income.
But as you saw with the GOOG example in my first article, sometimes a stock drops out of nowhere and the name of the game then becomes “Rolling with the punches.”
Trade well,
Jack Carter