If your club has given some thought to using options, but has not yet taken the plunge, this article may provide an impetus to begin.

In my experience, the largest hurdle for investors to overcome when they consider writing covered call options for the first time is the realization that this strategy forces them to establish a maximum profit from stocks they own. Investors dream of owning stocks that double again and again, - but these companies are difficult to find. Unless you have a proven track record of doing so, it's best to face reality. Studies show that most individual investors, as well as most professionals (mutual fund managers), cannot consistently earn a return that exceeds the market averages. When writing covered calls your portfolio is not only safer (less subject to wild ups and downs in its value), but it has an increased chance of outperforming the market (Data available to back up this statement). But the price to play the game of covered call writing, is accepting a limit on your profit potential.

Let's look at a specific example. Pfizer (PFE) is owned by the greatest percentage of Bivio's member clubs. Unfortunately this stock has been in a downtrend for some time. If you want to continue to own PFE, the question is:

• Are you more likely to make money from an increase in the stock price or
• Are you more likely to make money by writing covered call options?

Last Friday (Jan 21, 2005) PFE closed at $24.48. The stock pays a 17-cent dividend in early February. Assuming you collect 4 such dividends over the course of one year, in order to earn a return of 20 percent, the stock must increase in value to 28.70 (increase of $4.22 + $0.68 in dividends for a total gain of $4.90, or 20 percent of the current price). You must decide if this is a likely scenario and if you consider this the best way to achieve that 20 percent gain.

Alternatively, you can write covered call options. Keep in mind if your club owns only 100 shares (the minimum for using this options strategy), commissions can be costly - unless you use a deep discount broker.

Here's how it works. On Monday, Jan 24, sell the Feb 25 call option (sell one call for each 100 share of stock you own). By doing so, you become obligated to sell your Pfizer stock at $25 per share - but only if the option owner elects to buy your stock. It appears (before the market opens on 1/24) you will be able to collect $45 per contract. That $45 is yours to keep. You will also be entitled to keep the dividend when it is paid.

There are only two possible outcomes when expiration day arrives. Either the option owner chooses to buy your stock (if that happens, you must sell), paying $25 per share, or the option expires worthless, relieving you of your obligation to sell your shares.

If the stock is above 25 when expiration day arrives in 4 weeks, you receive $2500. Remember you also collected $45, giving you a net selling price of 25.45 for a one-month profit of $97. That represents a return of 3.9 percent for one month (4.7 percent, including the dividend).

It's important to mention that you do not have to sell your shares. You may, if you prefer, repurchase the call option (before it is exercised by its owner) you sold earlier, and simultaneously write (sell) another call option expiring in March (or some later month). By doing so you maintain ownership of your shares and collect additional cash. It's this monthly cash inflow that makes covered call writing so attractive.

If expiration arrives and the option owner does not elect to buy your shares, you are free to write another call option the following month. You can do this month after month. The amount you can collect when selling the call option varies. If PFE declines in price, then option buyers will not be willing to pay as much for the options, and you may have to settle for less than the $45 available this time. If the stock is higher, then you should be able to collect a higher option premium. Some (4 times per year) expiration 'months' are five weeks long (Note: Expiration day is the 3rd Friday of the month) and you will collect a higher premium for a 5-week expiration than for a 4-week expiration. The point is - you cannot be certain of future option prices, but if you average $35 per contract, you will, before trading expenses, collect $420 plus $68 in dividends for a total return of $488, or 19.9 percent of the current value of PFE stock.

In this example, you earn a return of twenty percent when the stock price does not increase in one year. In the real world, it's not so easy. If the stock drops further, you may not be able to receive much cash when writing options. Of course, if that happens, you will be better off than if you did nothing. It's also possible that the stock might stage a recovery. If PFE rises to $30, you would have been better off by simply holding. Since we cannot foresee the future, you must determine which approach gives you the better chance to earn a good profit from your Pfizer stock. There is no 'right' answer. Each investment club must determine an appropriate investment strategy for itself.

Writing covered calls requires a small amount of effort: Your club must choose which option to write. You must decide whether to write options that expire every month (as in this example), or less often (every 3 or 6, or even 12 months). You must determine if your commissions are too high to make this a worthwhile strategy and whether to consider changing to a deep discount broker. But, if you do decide this is worthwhile, you increase the likelihood that your club will be profitable - and if it's a down year for the market, your losses (if any) will be reduced by the amount of option premium you collect.

Keep in mind that it's okay to start small. Choose one of your holdings for a covered call writing program. If your club members enjoy this strategy and if it's working for you, you can consider rounding out all of your holdings (to increments of 100 shares) so you can write call options against each.

May all your options be winners.

Mark D. Wolfinger