Option Series #1 Covered Calls

Ohio State football  coach Woody Hayes  is one of a few who is accredited with saying that when you put the ball in the air, three things can happen and  two of them are bad.  In the Equity markets three things can happen when you purchase a stock. It can go up, down or sideways.  Only one of these outcomes is good.  In contrast, with a Covered Call, the same three things can happen to the underlying stock yet two are good.

A covered call is an investment strategy that may help investors manage risk,  enhance returns and simply make money during sideways markets.  A covered call is one of the most conservative ways to participate in the equity (stock) market and this strategy actually entails less risk than simply being long (owning) a stock outright.

Covered Call Worksheet

With this strategy you are making a purchase and a sale.  You buy a stock and sell a "call option".  Selling a call option is also know as "writing" the option and accordingly covered calls are also known as  "buy writes".  When you sell a call, you are essentially giving the purchaser of the call the "option" or "right" to purchase (from you) the shares of the underlying stock at a given price and for a specified period of time. The  price at which you are committed to sell throughout the duration of the options contract is referred to as the "strike price".  Allow us to take you through an example.

In the above table you can see that 100 shares of Verizon are purchased price of $32.89.  At the same time a call option is sold with a strike price of $33.00 and an expiration date of 3/15/2011.  You receive $1.46 upfront and also receive the dividends of 49 cents per share each quarter that you hold the stock.  As the table depicts, even if the stock were to go absolutely sideways you still earn 9.32% for the six month period which equates to an annualized return of 20.62%.  If the stock is higher and is "called away" you earn a tad more and should the stock go lower you have a 8.91% "downside buffer" before you would lose money on the strategy.For some investors a Covered Call strategy can play an integral  role in mitigating risk and enhancing returns.  The strategy can be particularly helpful during periods of consolidation or sideways movement for the market and for holders of concentrated equity positions.