Stocks & Commodities V. 29:2 (12-20): Investment VS Trading In Covered Call Writing by Jay Kaeppel

Stocks & Commodities V. 29:2 (12-20): Investment VS Trading In Covered Call Writing by Jay Kaeppel
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Investment VS Trading In Covered Call Writing by Jay Kaeppel

With the investment approach, shares of stock are viewed as rental property and calls are written to generate additional income from what is expected to be a longer-term stock investment. The trading approach involves executing buy/writes based on the possibility of generating a high annualized rate of return on a given stock/option combination. Which is better?

IT can be argued that covered call writing is the second-most commonly used option trading strategy, trailing only straight call and put buying. This is not surprising, since many investors assert that covered call writing is tantamount to collecting free money. While this is not actually true, in order to understand why this belief persists, let’s first look at what constitutes a covered call.

A covered call position simply involves buying and/or holding shares of stock and selling a call option against that stock position. For example, an investor might buy 100 shares of Ciena Corp. (Cien) for $14.04 a share and then sell a call option with a strike price of $14. When he sells the call option, the option seller is paid a premium by the option buyer. In return, the option seller agrees to sell his shares of stock to the option buyer at the strike price of $14 a share if called upon to do so. In this example, the option seller received a price of $0.78 for the option, or a premium of $78 (each stock option is for 100 shares of the underlying security). The amount of premium received will vary based on several factors, including:

• The amount of time left until the option expires • The volatility of the underlying stock • The distance between the strike price and the current price of the stock.

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