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Covered Calls Options Trading Strategy

Stock-Markets / Options & Warrants Dec 29, 2009 - 01:55 AM GMT

By: Jay_DeVincentis

Stock-Markets

Best Financial Markets Analysis ArticleThe basic covered call is a relatively simple strategy. The owner of a security sells the right to have their security purchased at a predetermined price in the future in return for money now. If the security price does not fall over the life of the option, the call writer will keep the premium collected when the call was sold. The call writer’s profit is limited in exchange for the premium.


Here's this week's top 10 list:

Strategies for covered call writing depend on the objective.

· Supplement Return
Covered call writers interested in supplementing the return of existing holding will tend to sell covered calls out of the money. The expectation is not that the security price will rise, but that it will not fall. The seller of out of the money calls often expects to continue holding the security, but hopes to reap some extra return from the proceeds of selling the call.

· Hedge Against Loss
Covered call writers can protect against downside price movement by selling in the money calls. This is commonly done after a rise in a security that is already held, to protect some of the gains that were already made. Although less time premium is collected on the call, the risk of loss is lessened by the amount that the call is in the money.

· Speculative Strategies
There are strategies that set objectives such as Doubling in 2 Years, or earning 10% a Month. A portfolio can be doubled in two years by successively selling covered calls that return 50% time premium for a term that last approximately 1 year. It is also possible to sell covered calls that return 10% in approximately one month. Both of these strategies require that the underlying stock price is at or above the strike price at expiration, and that this goal can be achieved repeatedly. Theoretically, a stock will lose some value 50% of the time.

· Risks of Covered Call Writing
Writing covered calls is generally considered a conservative option strategy. This only holds true if covered calls are written on conservative stocks. The covered call writer will suffer losses if the underlying security price drops. The most significant measure of this risk is the volatility. Writing covered calls on stocks with low volatility is conservative. Writing covered calls on highly volatile stocks is inherently more risky.

· Effect of Dividends on Calls
When a stock pays a dividend, the price of the stock is reduced by the amount of the dividend. For example, if Frontline (FRO) closes at 41.50 and pays a $2.00 dividend, the open price will be adjusted downward prior to the open to $39.50. There may appear to be an advantage to the call writer, since it is known that the price of the stock will drop. Why not sell the $40 call when it is known that the stock will drop $2? The short answer is that the call is discounted to reflect the impending drop in the stock price.

Here's this week's top 10-20 list:

If you have any questions or comments, email me at Jay@stockbarometer.com.

Regards,

By Jay DeVincentis


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Important Disclosure
Futures, Options, Mutual Fund, ETF and Equity trading have large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in these markets. Don't trade with money you can't afford to lose. This is neither a solicitation nor an offer to buy/sell Futures, Options, Mutual Funds or Equities. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed on this Web site. The past performance of any trading system or methodology is not necessarily indicative of future results.
Performance results are hypothetical. Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not actually been executed, the results may have under- or over-compensated for the impact, if any, of certain market factors, such as a lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown.
Investment Research Group and all individuals affiliated with Investment Research Group assume no responsibilities for your trading and investment results.
Investment Research Group (IRG), as a publisher of a financial newsletter of general and regular circulation, cannot tender individual investment advice. Only a registered broker or investment adviser may advise you individually on the suitability and performance of your portfolio or specific investments.
In making any investment decision, you will rely solely on your own review and examination of the fact and records relating to such investments. Past performance of our recommendations is not an indication of future performance. The publisher shall have no liability of whatever nature in respect of any claims, damages, loss, or expense arising out of or in connection with the reliance by you on the contents of our Web site, any promotion, published material, alert, or update.
For a complete understanding of the risks associated with trading, see our Risk Disclosure.

© 2009 Copyright Jay DeVincentis - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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