Covered calls – A conservative strategy with a lower risk than a standard stock portfolio

WHAT IS A COVERED CALL

  • A Covered call is a stock strategy where you give up gains against payment over a certain level.
  • You can choose the level where you decline further gains for a stock.
  • You can choose for how long you give up further gains of the stock.

 

STABLE RETURN

  • Reduces uncertainty for investors, who receive a fixed amount directly instead of a uncertain upside.
  • A covered call is more forgiving, you don’t need to be right about the market so often and can still achieve a good return.

 

OPTION FACTS

  • 60-80% of options end up being worthless at the expiration day. The daily erosion of value is one argument for selling options.
  • The sellers are professionals such as insurance companies and sophisticated asset managers.
  • Buyers are often speculative and/or private individuals.

 

THE TIME VALUE WORKS FOR US

  • Does not give any fast, large gains.
  • Gives a regular income when repeated on a regular basis.
  • Provides flexibility better than most investment strategies.
  • Buying options is speculation …
  • … Selling options against shares is investing

 

TWO ALTERNATIVES

  1. Sell call option against existing shares in portfolio.
  2. Buy shares and sell options (buy-write).

 

THREE SOURCES OF  PROFIT

  1. Sold options (”the Premium”).
  2. Dividend from the stocks.
  3. A part of the increase of stock price.

 

WHEN DO YOU MAKE MONEY?

COVERED CALL STOCK
  • STOCK MARKET – UP
  • STOCK MARKET – FLAT
  • STOCKMARKET – SLIGHTLY DOWN*
  • STOCK MARKET – UP

* if bigger declines occur, the covered call loses money but always less than the stock.

Both sides normally receive the dividends in a flat market.

 

7 ADVANTAGES WITH COVERED CALLS

  1. Receive money into the account from day 1.
  2. Increase the probability to make money.
  3. Allows holder to make a profit of 15-40% per year, if executed in a skilled way.
  4. Protects portfolio on the downside.
  5. Still has a part of the upside left (limited).
  6. Can make adjustment without buy/sell of shares.
  7. Can adjust the risk level.

 

INVESTMENT PROCESS

  • Follow stock price daily for sign of strength and weakness.
  • Follow the news for specific stocks and general economic and political news.
  • Select suitable call options considering expected and historic movements in the stock.

Consider the implied volatily (option premium), expiry period and strike price.

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