Covered call writing is a very commonly used
strategy. For good reason. Most of the time it is profitable to adopt
this strategy, and over the longer term, it provides superior returns
with less overall risk. That's a great combination and is a wonderful
strategy for learning how to use options.
The negative feature of this method is that it affords minimal
protection against a market collapse, and money is lost when the
markets tumble. True, the covered call writer loses less than the
stockholder - but for most investors, that is not a big consolation.
'Write' is the same as 'sell'
A covered call is a hedged option position where calls are sold
against a long position in the underlying instrument. In essence, the
trader is limiting profit on the long position in exchange for
receiving the option premium. One call option is sold for each 100
Buy or own 400 shares of General Electric, GE
Sell any 4 call options; perhaps 4 GE Sep 16 calls
Each option gives the buyer the right to
buy 100 shares of GE @ $16.00 per share at any time before the option
expires (after the close of business on the 3rd Friday of September).
Why would a stockholder do this? Why limit profits?
- Stocks do not always rise
- By selling this call, you receive ~$53 per contract [That's
$0.53 per share]
- You get that cash now and it is your to keep, no matter
what else happens
- In this example, that $53 represents a return of more than
- Plus you get to keep the dividends
- Plus, if the stock dips you earned $0.53 that cushions
any loss - when other stockholders earned nothing
- You get those advantages in return for sacrificing any
profits above $16 per share
- If the stock is above $16 at expiration, the option owner
will take your shares and pay $16 per
- This is the obligation you must accept in return for the
It's a trade-off. You get some nice benefits, but no one buys that
option just to give money to you. That's why there is an obligation to
sell shares. Is this a good strategy for you?
to be continued...
Mark D Wolfinger
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