One of the keys to covered call writing success is knowing how to determine support and resistance levels. A support level is a stock price low that the price has hit and recovered from to advance back up due to more buying than selling of shares. This is referred to as the trading floor until a stock price breaks below it. The resistance level is a higher level that the stock price has hit and pulled back due to more selling than buying of shares. This ceiling acts as resistance that the stock price must break through to advance higher.
The more times the price has hit a support or resistance level, the stronger it is and more difficult to move through it. The longer it takes for the stock to test
these levels, the stronger they are to break through. For example, an intraday test is not as strong as a one week test of these levels. The higher the stock volume at the level, the stronger the level is holding. For example, if volume is above average and the stock price doesn’t break out then the level will hold and be more difficult to go through.
Most technicians draw the support and resistance levels at the lowest and highest price points on a stock chart. If stock price reached a certain support or
resistance level multiple times, you can safely disregard a single price spike above or below these levels.
How can the covered call writer use these support and resistance levels. If a quality stock has successfully tested the support levels, then you know where the price bottom is for that stock. You can also use the support level to tell you when to react as a break below support requires a new decision on what to do with your covered call – close it, roll out, etc. The other use of support and resistance for the call writer is to delay entering a new trade when a support or resistance level is being tested. These price points should be watched closely to see if they hold. If they do not hold, then be prepared to make
a decision on managing the covered call trade.
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