Continuous Covered Call Writing

| November 30, 2011 | 0 Comments

Covered call writing is one of the most popular options strategies out there.  It’s also one of the easiest for beginning investors to master given the proper guidance.

As a matter of fact, when talking to my friends, I commonly hear things like, “Covered call writing is a piece of cake,” and, “I do it all the time.”  They think they know it all, especially when I continue to hear, “What’s so tough, I buy stock and sell options.”

But when I ask them how often they use this strategy, the answer is always the same.  They say they use it every so often as they have time.  None of them apply a systematic approach.

While many think covered call writing is easy, there’s a little more to it. Like any option strategy, successful covered call writing requires strict discipline.

When you add discipline to covered call writing, it can be much more profitable.

And I’m not just making a hypothetical observation.  Back when I was running a $100 million portfolio of stocks and options strategies, I used this disciplined covered call writing strategy over and over with great success.

I call it the “Power of Continuous Writing”.

Before I explain how it works, let’s quickly review the basics of covered call writing.

First, you buy 100 shares of a stock that you wouldn’t mind owning for the long run.  Then, you sell one call option at a strike price of your choosing.  At expiration, one of two possibilities occurs…

One, the stock closes above the strike price and gets assigned.  In other words, you’re forced to sell your stock at the call option’s strike price.  The premium received and stock appreciation up to the strike price is your profit.

Two, the stock closes below the strike price and your option expires worthless.  When this happens, the premium from the option you sold is your profit.

So, getting back to the strategy…

The way this strategy works best is to continuously do it over and over.  In the long run, you’ll be amazed how much more money you’ll put in your pocket.

You see, true professionals are quick to re-write their covered calls.  By doing this, the pros are able to keep their money working for them.  This allows them to continuously collect premiums on cash that otherwise would be sitting in a money market fund earning next to nothing in interest.

Here’s an example of how profitable the Power of Continuous Writing strategy can be…

Let’s say you bought 100 shares of DuPont (DD) on May 22, 2007 at a price of $52.63 ($5,263).  Now, assume you sold the $55 strike call option on your DuPont shares continuously every six months.

In other words, as each option expired worthless, you immediately sold a new one.  If your stock got assigned at expiration, you immediately bought it again and sold another call option.

Most importantly… you continued this process for four straight years.

Believe it or not, it makes a world of difference.

If you merely bought the stock and sold it four years later, you’d have made just $6.66 per share.  Obviously not the best return over a four year span.

On the other hand, if you wrote a new call every time your position closed, your results would have been much better.  After the same four years, you’d have made a healthy profit of $30.66 per share.  Between capital appreciation, accumulated dividends, and premiums received, you’re looking at a 58% total return.

That’s nearly five times the return you would have made just buying and holding.

If that’s not convincing, I don’t know what is!  Well… in addition, DuPont essentially traded flat over the four year period.

Bottom line…

I’ve never been able to understand why everyone doesn’t take advantage of this type of strategy.  It doesn’t cost anything.  And it’s clear you have nothing to lose.

All you need is a little time to make the Power of Continuous Call Writing part of your portfolio.  Reduced down to its simplest terms, it allows you to compound option premiums without investing any additional capital.

So, don’t go on wondering why you haven’t been using this strategy… get out there and do it.  You’ll feel great when your covered calls are generating solid returns time and time again.

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Category: Options Trading

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