Saturday, 12 March 2016

BEAT THE MARKET: COVERED CALL WRITING

A CONSERVATIVE OPTION STRATEGY
COVERED CALL WRITING is a strategy designed to modify an investor's profile. It is not a magic strategy. 
·         It a strategy for investors with a bullish bias. 
·         It is not suitable for the very bullish investor because profits are limited.
·         It is appropriate for investors who want to slightly outperform the stock market over an extended time -- and to achieve that result with a less volatile portfolio (i.e., the value of the portfolio experiences smaller losses when markets decline and smaller profits when markets surge.) 
When you own individual stocks, exchange traded funds (ETF), or mutual funds, the value of your portfolio (obviously) moves up and down with the general movement of the stock market. As an investor, you may not have thought about the truth of the following statements, but in the back of your mind you surely understand that they are true.
·         Owning an ETF -- especially an ETF on one of the broad based indexes -- is an attempt to match the general performance of the stock market. The investor is not searching for ways to beat the market -- merely to match its performance. Such ETFs include: SPY (based on the S&P 500 Index), IWM (based on the Russell 2000 Index) , and QQQ (Based on the NASDQ 100 Index).
·         Investors who buy mutual funds are looking for out-performance, trusting the professional portfolio managers to choose investments that do outperform. In general, this is a poor investment plan because most fund managers fail to to beat their benchmark indexes. On top of that, they change an annual management fee for their failure. If you prefer to allow others to manage your money and make investment decisions for you, then you will probably do better with index funds and index ETFs, rather than traditional mutual funds. Sure, some mutual funds produce outstanding gains, but how are you supposed to find those funds in advance? You cannot.
COVERED CALL WRITING
When writing covered calls, the most important part of the strategy is choosing which stock to own. It is true that you can add to your profits by skillfully trading the options, but that pales in comparison with how your overall results depend on whether the stock rises or falls. The objective with covered call writing is to find stocks that do not lose significant value. There is no need to find stocks whose prices skyrocket.

The "regular" stockholder wants the price his/her stocks to rise indefinitely. However, the goal of the covered call writer is to own stocks that do not decline in value. This makes a significant difference when choosing stocks to own. The stockholder has unlimited upside possibilities, along with the chance to lose a lot of money when the stock price crumbles.
HOWEVER, THE COVERED CALL WRITER:
·         Sacrifices the opportunity to earn a huge profit in return for better results when markets are not rising.
·         This is a trade-off that works for most investors. However, if you seek unlimited gains (greedy) are believed that the markets never decline (very bullish), this strategy is too conservative for your needs. 
HOW IT WORKS
Buy stock in multiples of 100 shares. That is easy to say. The much more important (and difficult) part of this investment is to only buy shares of a stock that you want to own. Do not assume that this strategy is so effective that you can select any old stock. Whenever that you own stock, there is downside risk. So choose your stocks carefully.
Next sell one call option for each 100 shares. There are usually many reasonable call options to sell. You can select from several expiration dates or strike prices.
It takes a longer discussion to explain how to make an intelligent choice from among those choices, but there is no such thing as the "best choice" for you. Your personal investment objectives are an important consideration. For example, investors seeking extra risk and extra rewards would sell out-of-the-money options, while those who prefer limiting profits in return for owning positions with less risk of losing money would write in-the-money options. Read about the philosophy behind covered call writing.

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