Author Archive
Covered Calls FAQ
Posted by: | CommentsThere are a few new terms and concepts to learn when you first begin learning about covered calls. They’re not that difficult, and covered calls are similar in many ways to other investment concepts. It is important to find good sources of information and to understand as much as you can before investing your money. Covered calls can be a good money making source, but they are not a fast path to instant riches. If you are looking to become wealthy overnight, then this is probably not the right strategy for you. But if you are interested in a reliable way to earn recurring monthly income, then covered calls make a good choice.
A few commonly asked questions among new covered call investors:
Covered calls are what, exactly?
Also commonly called a “buy-write” by some investors, a covered call is simply when an investor thinks that a stock has a good long term outlook but expects that the short term will stay relatively stable and trade within a few dollars of it’s current price. In this situation, the investor will then sell call options on the stock while simultaneously holding a long position on the stock. This is in the hopes of generating some income on the premium.
Remind me what “long” and “short” mean in the context of stocks.
If you are “long” a stock then that means you own it. You bought the stock and if it increases in value then you will make money. If you are “short” then it means you have sold a stock that you do not own. In the future (at some point) you will have to buy it back to “cover” your short position.
Ok. But how do I make money?
You sell call options to buyers that allow them to purchase at a predetermined price, and they pay you a “premium” that is yours to keep whether the option is exercised or not. This guarantees you premiums regardless of the outcome, and creates income that you can count on.
When should I sell call options?
You can sell call options against your stock at any time. In fact, you could do it every month if you want to (and generate recurring monthly income). You would not want to do it if you expect the stock to shoot up in value in the very near term. By selling the option you are putting a cap on your upside for the stock (in exchange for the option premium you receive). The best case, for you the option seller, is to have your stock stay the same between the time you sell it and its expiration. That way you collect the option premium, break even on the stock, and can do it again the following month.
Investing in covered calls is not difficult. It is the most common options-based investment strategy (Schwab says 84% of their option enabled accounts will do covered calls). Having a good covered call screener at your side will save you time (much better than a manual spreadsheet). If you’re not selling calls against stocks you already own then you’re leaving money on the table each month.
Born To Sell, http://www.borntosell.com, is a website dedicated to covered call trading. Use this link to check out Born To Sells site on covered call investing.
Understanding The Risks Of Investing In Covered Calls
Posted by: | CommentsThe most common options-based strategy is called “covered calls” and consists of owning stock long while at the same time selling call options against that stock. Although it is an excellent way to generate recurring monthly income from a portfolio of ETFs and stocks, it is not without risks.
One risk that some investors overlook is the tax risk. Many investors write calls against core positions they’ve owned a long time (at a low basis) to generate income each month. Good strategy but if the buyer of the option you sold exercises early then you may have to surrender your stock for the strike price, thus creating a tax event for yourself. Now, it’s usually pretty easy to keep tabs on this possibility because as long as there is time premium remaining in the call option it does not make financial sense for the holder to exercise (he would do better by just selling his option instead of exercising it).
But some investors do crazy things, including exercising options that have time premium remaining. That, in turn, could cause a tax event for you if the stock lives in a taxable account. If your stock is in an IRA (or other non-taxable account) then it’s no big deal. If you still like the stock just go into the open market and buy more with the proceeds from the assignment. The possibility of an early exercise increases just before an ex-dividend date, because the option holder may exercise to get the dividend. But again, if there is time premium remaining in the option then he is usually better off just selling the option rather than exercising it.
Next risk is the lack of upside potential above the strike price. The covered call writer can set the strike price to whatever value he likes, but one thing certain — whatever value he sets it to is the most he will receive for his stock between today and expiration. If there is a positive surprise of any kind (M&A takeover, earnings beat, increased guidance, competitor fails, etc) and the stock rises above the strike price then the covered call writer will not make as much as he could have made if he hadn’t sold the call.
Downside protection is good, but should not be leaned on as a savior to prevent all losses. The option premium you receive cushions the first part of any loss but if the stock drops significantly then you will probably still have a loss (less than a buy and hold investor, for sure, but it’s still a loss). Often cited as the tradeoff for putting a cap on your upside potential, it is definitely a good feature of the strategy but just be aware that you can still lose money with covered calls.
And then we come to high yield chasing. It is very tempting to use a covered call screener to identify the high yield covered calls and then start writing them. But the screener is just the 1st step in any covered call writing program. After you get a list of candidate trades from the covered call screener you then must do additional research to understand why those premiums are so high. You can make a great return with covered calls but like any other investment strategy you must be prudent and proceed with carefully researched caution.
If you would like to find out more go to this site.
Writing Covered Calls On Emerging Markets And Gold Using Exchange Traded Funds
Posted by: | CommentsETFs (Exchange Traded Funds) are collections of securities that trade like a single stock. The more popular ones are optionable (meaning there is a market for puts and calls on the ETF) so you can use them to sell covered calls. They make sense for covered call writers because of the inherent diversification they provide (especially true in accounts that may not have the capital to buy many different stocks for diversification). There is no single-stock risk with an ETF. If one of the member stocks drops suddenly then the effect will be felt less by the ETF that contains that stock than by the single stock itself.
Some ETFs track specific indexes, allowing a low-cost way to trade the index. For example, the symbol IWM represents an ETF that is comprised of two thousand stocks that make up the Russell 2000 index. When you buy IWM you are buying a basket made up of 2000 stocks. Other popular ETFs include QQQQ (NASDAQ 100) and SPY (for the S&P 500). And there are ETFs to track specific countries, sectors, or commodities. For example, EWJ tracks Japan, XLF tracks financial stocks, EWZ tracks Brazil, and GLD tracks gold.
The ETF with symbol GLD is an interesting one given the interest from investors in owning gold. However, GLD doesn’t pay a dividend. But, by using covered calls you can create dividend-like cash from gold, too. Just buy a gold ETF and write calls (in-the-money if you’re neutral to bearish on gold or out-of-the-money if you’re bullish on gold). GLD is by far the most liquid (meaning, most capital invested, and most highly traded) gold ETF and probably the best bet for covered call trading. Other ETF choices include DGL which has small open interest (not good), and UGL which is 2x leveraged and therefore quite volatile (not good).
To be diversified you need some emerging markets exposure in your portfolio. But given the challenge of finding reliable, solid information on companies in foreign countries, the safer way to play emerging markets is with a group of stocks in an ETF. The most popular emerging market ETF is EEM (iShares MSCI Emerging Markets Index Fund), which has over $39 billion in assets and is about as liquid as it gets. If you want to limit your exposure to a single country, say China for example, then you can use FXI (iShares FTSE/Xinhua China 25) to write calls against.
There is one kind of ETF that you should not get involved with for covered calls, and those are the leveraged ETFs. Leveraged ETFs are designed to be much more volatile than an unleveraged ETF. You can usually identify leveraged ETFs because they have words in their name like “double”, “ultra”, “triple”, “2x”, “3x”, or “leveraged”. Leveraged ETFs are mostly used by day traders and are not appropriate for conservative income-oriented investors. It can be tempting because the premiums are usually pretty high. But there’s a reason for those fat premiums, so beware! Leveraged ETFs are, by design, two or three times more volatile than their unleveraged counterpart.
Born To Sell’s covered call tools are excellent for covered call investing. If you sell in the money covered calls then you reduce your upside potential to just the time premium part of the option.