Covered Call Writing Irony

In almost every conversation I have with friends and colleagues one of the topics is investing; how is Mr. Market treating me? After 25+ years of blocking investment punches with my face, I can now report it’s really great!

The next question is just exactly what do I do and my answer is covered call writing for both income and higher portfolio returns. The next comment is usually something like “those are options and options are risky.”

Just smile at the irony!

Most investors, even experienced ones, fall into the “hope as a course of action” category when it comes to investing. They buy a stock or ETF for whatever reason, and HOPE it goes up (assuming they are not short sellers). After all, everyone is brainwashed into picking winners and how to pick winners. Maybe they watch every day, maybe once in a while. If the stock is up, they feel good, if the stock is down, woe is me and it’s not a good day.

Therein lays the irony; while “retail” investors are wringing their hands and hoping, professional investors are banking 3% to 5% a MONTH on their holdings no matter if the stock is flat and even if it goes down.

There is a covered call writing strategy for every market

Imagine the freedom and peace of mind selling (writing) covered calls brings. Say you have a nice dividend stock like Merck (MRK). Merck goes up and down, across the board has not missed a dividend in 10 years. Merck at the time of this writing is in the high 30’s and probably pays a 4%+ dividend. The option premiums are volatile (in this case that is good, meaning they are high enough to be worth your while to sell them.) With the stock near $37, you can sell the front month $37 call for $1.70 for a 4.5% return if assigned! This is beautiful; the stock can do nothing for the next 30 days and you bank $1.70 per share in spendable cash!

This is no hope here; just a really profitable reality. There is a reason why large institutional and hedge funds make the kind of returns they do; covered call writing is one of their strategies.

What if ....

You may ask what if the stock declines. First, you banked $1.70 so the new basis is $35.30, providing some nice downside protection. If you decided to make Merck a core portfolio holding and plan on selling (writing) covered calls monthly, you could use a “married put” strategy and buy a long-dated (say 4 to 6 month) put at a strike price that suits your risk. In this case, the July 2010 $34 puts are $.78 and are easily paid for by the initial $1.70 premium.

In a disaster or melt down, since you own the stock at $35.30 and the puts kick in at $34, you are at risk for $1.30. That’s it. If the stock tanked, the puts would more than make that up. If the stock stayed in the limbo zone of $35 or so, not to worry; just sell the next month’s call and you are not only even, you are most likely profitable.

Options were invented for insurance

Most investors are not aware that options on stocks were invented as insurance; a form of protection for stock portfolios. The Chicago Board of Options (CBOE) estimates that over 80% of options expire worthless. In that case, the odds are stacked in our favor to become an option seller versus an options buyer.g.

Discovering how to sell (write) covered calls can take much of the fear and risk out of investing. It also generates predictable monthly cash flow that is yours to keep no matter what is happening in the world. Click here for your free 50-page Expert Covered Call Strategy Report. Learn, earn and sleep well!