One of the Safest Options Strategies

By Alexander Wissel

We get many interesting reader comments here at Investment U and see our fair share of positive and not-so-positive comments.

A reader recently took issue with a line in “Dump GE & Buy This Safer Income Investment Instead” that stated writing covered calls was “(the only safe options strategy).” I think they’re missing the point of the suggestion on covered calls.

In short: it is. Writing covered call options is the only way not to lose money on options. Even L.G. McMillan would agree with that. The article never mentioned anything about losses to the underlying security – which is entirely possible.

I can hear the whining starting right now, but let me address exactly how it is one of the safest options strategies. If you aren’t familiar or comfortable with options, I suggest taking a look at “Selling Call Options.”

Additionally, if you’d like to know the second best way to use options, and one of the best ways to purchase stocks, see “Put Option Selling.”

More On Stock Option Strategies…

Options strategies are basically bets against the market and time. They seek to use the power of leverage. Unfortunately, if time runs out and an option expires worthless, it’s a bad investment. It may not have been a bad hedge, a bad bet, or a bad speculation – but it was a bad investment.

In fact, roughly 80% of options expire worthless. It’s why options have so much risk. Wouldn’t you want to be on the opposite side of that equation? It’s what covered calls do.

Let’s turn our attention to the underlying security from that option. It’s at risk when you write an option on it – you won’t be able to sell it until the option is covered or expires. During that time period you could lose money.

In a worst-case scenario you could see the value of your holdings drop to zero. But unlike the other holders of that stock, you would at least have the benefit of the amount you collected from selling the call. The collection of call premiums is what makes this strategy a safe options strategy.

There’s No Such Thing As A Risk Free Investment

Remember, there is no such thing as a risk-free investment. Some investments are safer than others, but all carry risk. A covered call is safe for its seller, but not without risk.

Selling covered call options is really for investors who have a timeline of at least five years who (unfortunately) have no intention of selling a particular stock. It works best in flat markets. And most importantly, it gives the seller immediate income.

Without doubt, options are much riskier than most investments. But some options strategies, like selling calls, are safer than others.

And as an additional side-note: The “worst advice ever” category is a highly competitive space, shared by these guys.

Comments

[H. T. Love:]

As a relatively new investor/trader, I quickly discovered the value of writing covered calls. With volatility high, I have garnered some very nice returns and harvested cash from both stocks that I wish to keep (write longer term out of the $$ - less % immediate return) and those I don't (sell in the $$ shorter term - greater, more immediate gains).

I have 10 rules I follow. Two are >= 2% short-term gain, price so that exercise also gets me a profit on the underlying for longer-term writes.

I typically reinvest the cash in other equities and write calls on them too.

As with interest, compounding works wonders. Even being a n00b, I'm S&P 500 +7%, partly some luck, partly through use of this strategy.

Caveat: since you are trying to buy low, don't always write immediately. If you are fairly certain there will be some short-term bump up in the underlying, wait for it and then write. This allows higher premium income and (possibly) a higher exercise price for the underlying if you don't mind selling.

I've more strategies I use that fit my view of a particular stock and/or market behavior.

Caveat # 2: if you're new, as I am, be prepared and accept some small (unrealized?) losses when you write for $1.00 and see later that you could have written for $2.00 as price/time changes occur.

Caveat # 3: Have patience. I've made less $$ often because I wanted to get $$ "locked in" by buying back too soon (I do this on stocks I want to keep long-term). I've gotten much better over the last few months and now get closer to my strategy targets much more often.

The neat thing is that I can "rinse and repeat" indefinitely.

Feb 04 09:10 AM

[DuffBeer:]

Hard to love and Alexander
This is something I too want to start doing . Would you both share with me
a few books,seminars or any eductional materials you find my help get me started. I am hoping to be able to purchase more micro beer with the profits.
Cheers DuffBeer

Feb 04 03:17 PM

[H. T. Love:]

Duff,

I'm sorry I can't provide much in the way of references. My background leads me to a lot of research online. I haven't yet spent any money on books.

Google is your fried here. The Options Industry Council has some good introductory material which I have successfully applied.

I'll try to put a link here, and then break it up (I've heard that links aren't allowed).

www.888options.com/bas...

That is, a www. followed by 888options., com, /basics, /default.jsp

No commas in the above.

I hope that helps.

HTL


On Feb 04 03:17 PM DuffBeer wrote:

>
> Hard to love and Alexander
> This is something I too want to start doing . Would you both share
> with me
> a few books,seminars or any eductional materials you find my help
> get me started. I am hoping to be able to purchase more micro beer
> with the profits.
> Cheers DuffBeer

Feb 15 01:43 PM

[Fred Thomson:]

his is a great article. Covered Calls has it's known disadvantages which the author points out very well. But a well disciplined covered call trading strategy can be very profitable and will beat stocks in all BUT the strongest bull markets.

Trading costs are another possible disadvantage, but again this can be gotten around by not paying ridiculous amount for trades - try Zecco for goodness sake. I've used them over a year now and they don't have great customer service - but it's is way cheaper.

Also, any covered call trader will need some sort of tool to help him make decisions on when to manipulate his positions. A great tool can be downloaded at coveredcallcalculator....

Mar 01 05:02 PM