In-the-Money or Out-of-the-Money? wrote:
> I enjoy reading your column on options.
> I have a friend who has been writing covered calls on his own stocks for several years and is teaching me how to write
> them. In my readings, it seems in-the-money calls are favored for conservative, successful investing. My friend
> likes out-of-the-money calls better. I calculate the uncalled and called returns and they can vary both ways. Can
> you give the pros and cons of both?
> Stefan Steinberg
> Hello Stefan,
> Thanks for the kind words.
> One of the negative aspects of writing covered calls is that it establishes a maximum profit for any trade. To me, that's just fine. Any time I earn that maximum, I am very pleased with the results. Thus, writing calls that are slightly in the money works well for me. My maximum profit is less than your friend might earn, but I have more safety, and I make money on a higher percentage of trades than he does. But, he has the potential to earn far more money that I can earn. Neither one of us is adopting the 'right' strategy, because there is no single best way to work with covered call writing. It's a versatile strategy and suitable for investors with different objectives.
> Those who are satisfied to earn a good (but not spectacular) profit and who want to earn that money with as much insurance against loss as possible, are happier writing in the money options. Those who are very bullish and who are willing to accept a greater risk of losing money as long as they have the opportunity to earn very large profits can write out of the money calls in an atempt to meet their investment objectives.
> Of course, a good compromise writing at the money options. That chocie represents a very happy medium for many investors.
> The bottom line is less risk, less reward vs. more risk, higher potential reward. Otherwise the pros and cons of covered call writing apply to either approach. The real difference between the two choices you mentioned is simply the risk/reward profile for the trade.
> Mark