FFO Options 11: Mastering The Covered Call Part II

1. FFO Options 11: Mastering The Covered Call Part II Dr. Scott Brown Stock Options

2. What all? • You sell the call buyer the right to take you’re stock in a future date if the share price trades above the strike price. • 2 ways to create a covered calls: • Sell one call option for every 100 shares you own. • You can do this with a “buy-write” order. • You buy the stock and write calls against it at the same time in the same transaction. • This is an easy way to have an additional passive income. • You earn option premium when selling the covered call.

3. Why? • Many call buyers purchase short-dated, out of the money(OTM), calls with low probability of profitability. • Time decay eats away at their positions fast. • Why would anyone sell covered call on a stock: • You can take in a lot of premium. • The probability of losing is low in a OTM Strategy.

4. How? • Concentrate on selling OTM calls. • Where the Strike Price is higher than current price. • Increases your buffer zone to win. • Gives you extra price appreciation possibilities. • Allows more upside gain while limiting the possibility of having the stock called away. • After finishing one trade, you repeat the process with a different expiration date.

5. Selling OTM covered calls • Selling OTM covered calls forces you to take profits along the way (assuming you are selling calls with strike prices above our initial stock buy price). • You have to realize that you are gaining price appreciation on your long stock up to the point of the stock price hitting your short call option. Once you hit the short call strike price, you will no longer gain any appreciation on your long shares. • In the event that the stock never reaches the short call strike, you will have reduced the cost basis per share of the stock. • Selling of covered calls can be quite advantageous for an investor; you sell calls every few months. • The call premium you receive is a consolation prize as you wait to see if your stock moves higher. • By selling covered calls, you’re taking a proactive approach with your money and gaining income on the stock you would never otherwise receive.

6. Investors worry about two things • Missing out on higher prices if assigned • Causing a capital gains tax event.

7. 4 Tactics To Secure Price Appreciation • Don’t get involved in covered call trading • Pick a further OTM strike to give you more cushion. • Offset the option trade at any time by buying back the option itself. • Buy more shares right after being assigned.

8. Strike price versus cost basis • Selling at strike prices below your cost–basis is not something you should do, because it could lock you into a realized loss. • There are some cases in which you decide to keep a stock to weather the storm through share price declines. • Because you believe in long term viability. • Selling covered calls at this time would not be a good idea. • There wouldn’t be a strike price you could pick that would give you current income without taking on the risk of being assigned at unfavorable prices

9. Strike price versus cost basis (Cont.) • If you chose to sell five of the $17 calls for $0.33 each (splitting the bid-ask), you would receive $165 in your trading account. • If INTSC happened to trade above $17 per share come the April 2009 expiration, you would be forced to give up your shares to the option buyer at a price of $17 per share, thus locking you into a realized loss of roughly $8 per share based on your initial cost basis of $25.50 per share. • The strike price of the options you sold ($17 strike) was too far below your original cost-basis level. • Now, if INTC doesn’t get above $17 by the April 2009 expiration, those $17 call options will expire worthless. In this case you would need to wait for INTC to move higher again so you could sell call options with strike prices above $25.50

10. What is the reasoning behind offsetting the option trade before expiration? • A couple of things: When an option trade moves in your favor quickly take the money off the table. • Selling covered calls gives you cushion and income to make you feel better while you watch your stocks fall in price. Think about all those times while you watched your stock fall in price and had no buffer against it. • This is the advantage of the covered call strategy.

11. Bottom Line • The bottom line is to make sure you sell calls against your stock because you never know when your shares will decline in price. Selling calls will buffer part of a decline if you opt to hold on to the shares.

12. Risk management • The risk management plan with a covered call strategy is no different than your normal “long stock” plan. This is because no matter how much the calls will shield you from a down move in the stock, it won’t shield you from a total loss if the stock falls to zero. Whatever your plan is, make sure you follow it. Everyone has a different situation, so everyone’s plan can be different. If you decide on a 25% stop-loss on a stock break up the position at that point. • In summary, selling OTM calls against long stock is a way to gain sideline income while you wait for eventual profit-taking at a sell target. If you are adamant about keeping the stock forever, then you concentrate on selling OTM calls to reduce the chance of assignment. • The continual selling in exchange for premium income, and hopefully the expiration of worthless options, will allow you to repeat the process many times during the year, lowering your cost basis each time. • As a hedging mechanism, covered calls area a prudent play. We all go through the ups and downs while owning stock.

13. Disclaimer • DISCLAIMER: THE DATA CONTAINED HEREIN IS BELIEVED TO BE RELIABLE BUT CANNOT BE GUARANTEED AS TO RELIABILITY, ACCURACY, OR COMPLETENESS; AND, AS SUCH ARE SUBJECT TO CHANGE WITHOUT NOTICE. WE WILL NOT BE RESPONSIBLE FOR ANYTHING, WHICH MAY RESULT FROM RELIANCE ON THIS DATA OR THE OPINIONS EXPRESSED HERE IN. DISCLOSURE OF RISK: THE RISK OF LOSS IN TRADING FUTURES, FOREX AND OPTIONS CAN BE SUBSTANTIAL; THEREFORE, ONLY GENUINE RISK FUNDS SHOULD BE USED. FUTURES, FOREX AND OPTIONS MAY NOT BE SUITABLE INVESTMENTS FOR ALL INDIVIDUALS, AND INDIVIDUALS SHOULD CAREFULLY CONSIDER THEIR FINANCIAL CONDITION IN DECIDING WHETHER TO TRADE. OPTION TRADERS SHOULD BE AWARE THAT THE EXERCISE OF A LONG OPTION WOULD RESULT IN A FUTURES OR FOREX POSITION.HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL, OR IS LIKELY TO, ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM, IN SPITE OF TRADING LOSSES, ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS, IN GENERAL, OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS. PS.  In our opinion, we believe, it may be possible, that heavy smoking and drinking may be hazardous to your health.  If you choose to smoke and drink while trading, The Delano Max Wealth Institute nor Dr. Scott Brown is liable for any damage it may cause.  If you slip and fall on the ice, we're not liable for that either.