How to Protect Against Losses on a 40% Drop Using Covered Calls

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The stock market is unpredictable, but with the right strategy, you can manage risks and still generate income even when stocks decline. In this blog, we’ll break down a real-life MicroStrategy (MSTR) trade, showing how to navigate earnings volatility, roll covered calls strategically, and protect against significant losses.

Understanding the MicroStrategy Trade Strategy

This trade is part of an ongoing strategy that has been documented over multiple videos. The goal is to maximize income through selling covered calls while managing downside risks. The key components of this system include:

Selling Calls for Income (Juice): Generating cash flow from option premiums.
Rolling Calls for Protection: Adjusting strike prices to maintain risk control.
Managing Whipsaw Movements: Avoiding excessive losses when stocks fluctuate unpredictably.
Tracking Performance: Using a structured spreadsheet to measure profits and losses.

Post-Earnings Adjustment & Risk Protection

Stock Movement Analysis

MicroStrategy (MSTR) has been highly volatile, trading within a large range, moving from $477 to $310 and back up to $344 post-earnings. The challenge is ensuring that options are strategically rolled to balance income generation and risk management.

Rolling the Covered Calls

Before earnings, 9 contracts at the 330 strike price were sold for $1,535 per contract. Now, with the stock at $344, those calls are being rolled to the 340 strike price for the next cycle. The key decision factors include:

Avoiding Assignment: Rolling the calls up ensures continued control of the stock position.
Collecting Additional Juice: The new roll generates another $1,255 per contract, bringing the total covered call income to over $12,000 for the week.
Maintaining Risk Protection: The move provides downside coverage while allowing for potential upside participation.

The Power of the Covered Call Strategy

While MicroStrategy has dropped 40% from its peak, this system has mitigated potential losses. Instead of holding the stock and suffering the full decline, the structured use of covered calls has helped maintain a breakeven position over a 10-week trading period.

Key Takeaways:

Risk Reduction: Selling calls has offset stock declines, reducing losses from 40% to near zero.
Consistent Income: Even during market uncertainty, cash flow from premiums supports portfolio stability.
Flexibility with Rolling: The ability to adjust strike prices allows for long-term profitability.

Real-World Math: How the Numbers Work

The initial purchase price of 9 contracts was $277,900. With the stock decline, the current base position is valued at $159,160. However, covered call income has generated $115,462 over the duration of the trade, offsetting the paper losses. The strategy aims to continue reducing the cost basis while allowing for recovery potential.

Life-Improving Tips for Financial Freedom

Diversify Your Income Streams – Relying on a single source of income can be risky. Covered calls provide a steady secondary income stream that can supplement your salary or retirement fund.
Stick to a Proven Strategy – Emotional decision-making can lead to losses. Following a structured system like the Cash Flow Machine ensures consistency and reduces impulsive trading errors.
Manage Risk Wisely – No strategy is foolproof, so implementing stop-losses, position sizing, and risk management rules is essential to protect your capital.
Be Patient and Consistent – Wealth is built over time. The key is compounding income by reinvesting your covered call profits into additional stock purchases.
Stay Educated and Adapt – The financial markets evolve, and so should your knowledge. Stay updated with new trading techniques, read books, and consider mentorship or courses to refine your skills.
Control Emotions in Trading – Fear leads to selling too soon, and greed leads to overexposure. Avoid knee-jerk reactions and stick to your system regardless of market fluctuations.
Plan for Taxes – Covered call income is taxed differently depending on your country. Understanding tax rules helps optimize after-tax returns and prevents unexpected tax liabilities.
Reinvest Profits Wisely – Instead of spending covered call income immediately, reinvest a portion to increase your stock holdings and amplify future earnings.

FAQs

Is this strategy safe?

Yes, covered calls are considered one of the safest options strategies. They provide steady income while reducing downside risk, making them ideal for conservative investors.

Do I need a large account to start?

Not necessarily. While having a larger account helps, synthetic options strategies allow traders to participate with lower capital.

What happens if the stock drops?

The premium collected from selling calls provides a cushion. Additionally, selling in-the-money (ITM) calls can offer further downside protection.

Can I lose my stock?

If the stock price exceeds your strike price, you risk having your shares assigned. However, you can roll the position forward to maintain ownership and continue earning premiums.

How much time does this strategy require?

Managing covered calls takes only 20 minutes per week or an hour per month, making it a highly efficient strategy for passive income.

What if the stock skyrockets?

If the stock rises sharply, you may have to roll your covered call to avoid assignment. While this caps upside potential, it ensures a consistent income stream instead of relying on speculation.

Can this strategy work in a bear market?

Yes! In a declining market, you can sell deeper in-the-money calls or hedge with protective puts to reduce losses and maintain cash flow.

Call to Action

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Conclusion

Market downturns are inevitable, but they don’t have to mean financial disaster. By utilizing covered calls strategically, you can protect against downside risk while continuously generating income. This trade demonstrates that even in a 40% stock decline, losses can be minimized, and future gains remain possible.

How to Protect Against Losses on a 40% Drop Using Covered Calls

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