Writing Covered Calls is a conservative strategy where you buy a stock that you would like to invest in and then write a call option against that stock.
This is a cash generating strategy that not only offers downside protection that you otherwise wouldn't enjoy if you just bought the stock, but also gives you the ability to generate a consistent monthly income, for only minutes of your time.
However as with all option trading strategies, there are pitfalls that you will need to avoid if you are to be consistently profitable.
What if the stock price falls dramatically? Your calls really do nothing to protect you against losses as the market falls. Sure, you get to keep the premium from selling the call (when it expires worthless), but you still own the stock, which is now worth considerably less than what you paid for it. The problem then becomes that you will not be able to sell another call at the original strike price. Instead, the next time you will have to sell the call at a lower strike price, or sit and wait for proper conditions for more call writing. If the stock then moves back to its original price, you will be assigned on the short call at the lower strike, locking in a significant loss. If the stock continues to drop, you will end up worse than if you simply accepted your loss after the first month and moved on. This is the main "knock" on covered writing -- that it takes away your upside profit potential but leaves you with the same downside risk as a regular stockholder.
Here are a few tips that may help you write covered calls successfully.Always check the fundamentals of the underlying stock and make sure that you would be happy to own even if options didn't exist.
A great resource for viewing fundamental 'ratings' for stocks is at http://www.morningstar.comDon't enter a Covered Call trade just because the option premium looks attractive. Higher option premiums (10-15% or more) often mean that the stock is more volatile i.e. prone to huge price swings and therefore greater risk.
I personally target the larger, more liquid and stable companies with monthly call option premiums between the 3-6% range. One of my personal favorites and a stock that I have had considerable success writing covered calls on over the years is Oracle (ORCL).
I've also had consistent success with Intel (INTC) and Nokia (NOK). At times the Nasdaq Tracking Unit (QQQQ) is also attractive (a 3% yield is the highest I've ever seen it though).Don't hold stocks at least 2 days either side of earnings announcements. Much of the time expectations of good and even great earnings are already priced into the stock and should the stock fall short of expectations or even worse disappoint, a virtual bloodbath can follow. I've experienced declines of 30-50% in just a few days by holding my covered call stocks over earnings announcements.
Don't get me wrong, it can also be good time to be a stockholder if the earnings numbers are really great, but I'm a little more conservative and to me it's just not worth the risk. You can always buy back in afterwards anyway!
Always take a look at stock charts when choosing a stock to write covered calls on. There are 3 general patterns that I look for:
1) A moderate uptrend.
2) A sideways trend.
3) However the most conservative/safe chart pattern for covered call writing (in my experience) appears after a stock has had a steep sell off and has begun to move sideways for a couple of months. This is a type of 'bottoming' pattern where much of the downside risk has already been 'sold' out of the stock.
As covered call writers it's always important to remember that our risk lies if the stock falls sharply, so we want to do our best to reduce the risk as best we can. This is just one way that I have found to be effective.
If you go to http://www.stockcharts.com and pull up the chart for the QQQQ during the early part of 2003, you'll see this exact pattern. I successfully wrote covered calls on the QQQQ for about 4 months during this time before I allowed myself to be assigned and moved onto another opportunity.
There you have it. Hopefully these tips help you on your way to consistent profits and monthly cashflow writing covered calls.
Happy option trading and investing!
This is a cash generating strategy that not only offers downside protection that you otherwise wouldn't enjoy if you just bought the stock, but also gives you the ability to generate a consistent monthly income, for only minutes of your time.
However as with all option trading strategies, there are pitfalls that you will need to avoid if you are to be consistently profitable.
What if the stock price falls dramatically? Your calls really do nothing to protect you against losses as the market falls. Sure, you get to keep the premium from selling the call (when it expires worthless), but you still own the stock, which is now worth considerably less than what you paid for it. The problem then becomes that you will not be able to sell another call at the original strike price. Instead, the next time you will have to sell the call at a lower strike price, or sit and wait for proper conditions for more call writing. If the stock then moves back to its original price, you will be assigned on the short call at the lower strike, locking in a significant loss. If the stock continues to drop, you will end up worse than if you simply accepted your loss after the first month and moved on. This is the main "knock" on covered writing -- that it takes away your upside profit potential but leaves you with the same downside risk as a regular stockholder.
Here are a few tips that may help you write covered calls successfully.Always check the fundamentals of the underlying stock and make sure that you would be happy to own even if options didn't exist.
A great resource for viewing fundamental 'ratings' for stocks is at http://www.morningstar.comDon't enter a Covered Call trade just because the option premium looks attractive. Higher option premiums (10-15% or more) often mean that the stock is more volatile i.e. prone to huge price swings and therefore greater risk.
I personally target the larger, more liquid and stable companies with monthly call option premiums between the 3-6% range. One of my personal favorites and a stock that I have had considerable success writing covered calls on over the years is Oracle (ORCL).
I've also had consistent success with Intel (INTC) and Nokia (NOK). At times the Nasdaq Tracking Unit (QQQQ) is also attractive (a 3% yield is the highest I've ever seen it though).Don't hold stocks at least 2 days either side of earnings announcements. Much of the time expectations of good and even great earnings are already priced into the stock and should the stock fall short of expectations or even worse disappoint, a virtual bloodbath can follow. I've experienced declines of 30-50% in just a few days by holding my covered call stocks over earnings announcements.
Don't get me wrong, it can also be good time to be a stockholder if the earnings numbers are really great, but I'm a little more conservative and to me it's just not worth the risk. You can always buy back in afterwards anyway!
Always take a look at stock charts when choosing a stock to write covered calls on. There are 3 general patterns that I look for:
1) A moderate uptrend.
2) A sideways trend.
3) However the most conservative/safe chart pattern for covered call writing (in my experience) appears after a stock has had a steep sell off and has begun to move sideways for a couple of months. This is a type of 'bottoming' pattern where much of the downside risk has already been 'sold' out of the stock.
As covered call writers it's always important to remember that our risk lies if the stock falls sharply, so we want to do our best to reduce the risk as best we can. This is just one way that I have found to be effective.
If you go to http://www.stockcharts.com and pull up the chart for the QQQQ during the early part of 2003, you'll see this exact pattern. I successfully wrote covered calls on the QQQQ for about 4 months during this time before I allowed myself to be assigned and moved onto another opportunity.
There you have it. Hopefully these tips help you on your way to consistent profits and monthly cashflow writing covered calls.
Happy option trading and investing!
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