INVESTING

Options Strategies

A call option is a contract that gives the holder the right to purchase the underlying security at a specified price for a certain fixed period of time.  

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Features

Sellers of call options receive a premium.  If the buyer decides to exercise the option, then the seller has to sell the stock at the strike price.  If the buyer does not exercise the option, then the seller profits from the premium.

Common wisdom is that return in a function of risk.  But is that really true?

At the money covered call writing is a strategy in which an investor sells an option with a strike at the current price of the underlying security. In this strategy the maximum gain is the amount that is received from the premium.

In the money covered call writing is a strategy in which an investor sells an option with a strike that is lower than the current price of the security. The further in the money the more conservative the strategy is, however, upside is decreased accordingly.

Out of the money covered call writing is a strategy in which an investor sells an option with a a strike higher than the current price of the security. This investor profits in the initial upside movement of the stock. The maximum gain is the premium plus the difference between the strike and the current value

 

Advantages

  • Downside protection (in the amount of the premium received)
  • Opportunity for enhanced return (if stock is up but below the strike price plus the premium)
  • Positive returns during slightly downward/flat markets
  • Selling a diminishing asset (Time decay)
  • As long as the investor holds the underlying they will receive all dividends paid
  • Potential tax planning advantages

Benefits

  • May reduce investment risk for the investor
  • There are many market conditions that provide greater returns.
  • May provide tax benefits

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