[dla133]

Hi,

I have traded shares over the last few years with some success. However I keep hearing claims of using a covered call strategy to get a 3% - 6% profit each month. Apparently you buy the share and the covered call at the same time. You get paid for the covered call which gives you an income. I understand that if the stock goes up you will only get the capital gain up to your strike price (You make a profit). I also undertsand if the share stays flat then your covered call will expire and you keep the premium and the shares. (make a profit). You can then write a covered call again. However I don't understand what happensif the share drops in value. I understand that your capital will go down with the share priice, but what happens to your covered call? Can you sell your shares and the covered call at some point below what you paid and still make money because you collected a premium? They say a little knowledge is a dangerous thing, and that is what I have with this subject, a little knowledge. I would also be trading from the UK so I'm not sure of the restrictions and who i would use to try this strategy out with a demo account. I'm sure this strategy has been around for some time with quite a few people trying to sell courses on it. (Investment Mastery, Cash For Life or The Protected Trader etc). Can anyone help me understand this strategy better and what the pitfalls reaaly are.

Kind Regards
Lee

[DugDug]

first - you really should learn a lot more before committing any money to such a strategy.
There is a lot more to it, and any course will give you only the basics and will more than likely sell you ideas and dreams without necessarily the required knowledge.
But to help you on the way.....

"Apparently you buy the share and the covered call at the same time."
the reason why it is called a covered call is that the stock is owned at the same time. If you sold the option without the stock it would be called a naked short sale. What you actually do is buy the stock and then sell (or write) the call at the same time....often called a buy and write strategy.

" You get paid for the covered call which gives you an income. I understand that if the stock goes up you will only get the capital gain up to your strike price (You make a profit). "
If profitable you will receive the difference between the original purchase price of the share and the strike price plus the premium received for the call that has been sold or written.
If the share rises higher than this, you do not participate in any more of the upside.

"I also undertsand if the share stays flat then your covered call will expire and you keep the premium and the shares. (make a profit). You can then write a covered call again. "
Yes - you either let the call expire worthless and then write a new expiry call, OR you roll the calls, buying back the original sold call and then selling a new call in another expiry.

"However I don't understand what happensif the share drops in value. I understand that your capital will go down with the share priice, but what happens to your covered call?"
the price of the covered call will (or should) decrease as well. You then have the decision of what to do....either buy it back, roll it down a different strike, close both shares and calls out. This is the problem.....you have to decide what to do still as all you have is reduced the cost of the shares, however you still have the risk of further declines. (always buy back the options is they are nearly worthless, dont sell the shares and not buy them back, otherwise you can get doubly screwed)

Can you sell your shares and the covered call at some point below what you paid and still make money because you collected a premium?
Yes - just do the maths, any broker or person who is offering you these services should be able to provide good systems to allow you to work out your breakevens on this....if they dont, then dont touch them as a broker. They should be able to provide payoff diagrams....there are lots of books and sites around that you can search for this info.

"They say a little knowledge is a dangerous thing, and that is what I have with this subject, a little knowledge. I would also be trading from the UK so I'm not sure of the restrictions and who i would use to try this strategy out with a demo account."
Cant help you there regards broker advice, or regulatory restrictions - you need to seek professional advice for your own circumstances. But again any broker worth using should be able to easily answer these questions if not dont use them. Also a demo account will take a long time assess as this is a long term strategy best applied form the approach of using a portfolio.
Also if you are not prepared to do the work and learn the info..... then you only have yourself to blame for losses, and yet I am sure if you make money you will pat yourself on the back and tell your self you are a genius.

A few things to remember - 1) how many people are returning 3-6% per month using this strategy in a professional manner...... dont get suckered into the hype.
2) you will still need to be buying the things that go up, and in that case, why cap or limit your upside by selling the calls against your holding unless you are a long term user of this strategy,
3) this involves a fair bit of money to make serious money
4) understand that the risk profile of the buy and write strategy is exactly the same as selling a naked put....if you wont sell a naked put you should not do this strategy....

[dla133]

Hi DugDug,


Thanks for clearing a few things up. You seem to have a good grasp of this strategy. You mention some books that explain this in detail. Do you know the title of any books which you would recommend that I read to learn more on this? The reason this strategy appealed to me was the opportunity of making consistent profits over the long term which would maybe help me subsidise my share trading as a second source.
If anybody else on this site who reads this post is already using this strategy from the UK with long term success I would love to hear from them.

Thanks again Dug Dug.

Lee

[DugDug]

glad to be of help, thats why these forums can be so good.

re books there are many available Amazon, google, options for dummies etc - but to really understand options and how and why they work as they do you should always go for the best book I have seen Natenberg Option Volatility and Pricing.
Its a tough theoretical read and I dont recommend it for anyone unless they really like this stuff, or are actually serious about learning it.
Ultimately spending time on the internet and various sites like this is the first and best option. (excuse the pun)
dont get caught up in the hype of people promising big returns.
Also - this strategy while it may give you consistent profits, will also give you some big losses..... its a trade off, and should first be approached from the point of view of asking yourself..... Do I want to hold the underlying instrument long term if I had to?
good luck.

[Tams]

covered call has the same payoffs as selling a naked put option.

there is no free money in this world...

[quickturtle]

You got that right....................

Originally Posted by Tams »

covered call has the same payoffs as selling a naked put option.

there is no free money in this world...

[Moxy]

Checkout the free webinars over at the CBOE. Dan Sheridan's video's are well worth a watch. He makes it entertaining too.

http://oiwebcasts.cboe.com/portal/v_h.asp

As well as owning the shares to do a Covered call, take a look at buying a Leap deep in the money. Will give about the same risk but with less capital outlay for your margin. One thing you have to do with options is learn to manage the position. Plan when to exit/adjust your positions before making the trade.

Pete (UK).