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Writing Covered Calls

Many financial advisors and more than a dozen websites advocate writing (selling) covered calls as a sound investment strategy. Thousands of subscribers pay millions of dollars to get advice on profitable covered calls to write.

I believe they are wasting their money. Writing covered calls only limits the potential gain you might enjoy.

Let’s take an example. You buy 100 shares of XYZ for $80 and write (sell) an at-the-money two-month call ($80 strike price) for $4.00. If the stock stays flat, you will earn 5% on your money for the period (plus collect a dividend if there is one). If you can do this six times a year (write a two-month call six times), you will earn 30% annually (less commissions); or so goes the promise.

(In the last chapter we showed that selling calls against a one-year option rather than stock results in a hypothetical 300% gain if the stock stays absolutely flat, or ten times the amount you could earn by writing calls against the stock.)

In this covered call-writing example, 30% is the maximum amount you can earn. No matter how high XYZ goes in price, you can never earn more than 30%. The bottom line truth is that you will NEVER earn that 30%. The reason is that no stock price ever stays the same. If the stock goes up by $5 in the first 60 days, you will either lose your stock (through exercise), or more likely, you will buy back the call you wrote, paying $5, and losing $1 on the call (but making $5 on the increase in the price of the stock). So for the first 60 days, you actually made a 5% net gain ($4 net gain on a $80 stock).

Presumably, you then sell another 60-day at-the-money call (now at the $85 strike) and collect perhaps $4.25. Then the stock falls back to $80. In this time period, you gain $4.25 from selling the call but you lose $5 in stock value for a net loss of $.75.

Your gains on the calls you wrote now total $3.25 for a 120-day period (you gained $4.00 in the first 60-day period and lost $.75 in hoped would earn you 30% for the year). At this rate (four months of activity), your annual return will be $9.75, or 12.2% on the original $80 stock. Commissions on six sales of calls over the year will considerably reduce this return — to 10% or so. Not a bad return, but certainly not 30%. And it’s an awful lot of work for a 10% return.

For a full explanation of an option strategy that is designed to outperform writing covered calls, check out Dr. Terry Allen’s Free Report on calendar spreads.

Terry's Tips Stock Options Trading Blog

February 20, 2017

Using Investors Business Daily to Create an Options Strategy

Today I would like to share an idea that we are using in one of our Terry's Tips’ portfolios. We started this portfolio on January 4, 2017, and in its first six weeks, the portfolio has gained 30% after commissions. That works out to about 250% for the whole year if we can maintain that average gain (we probably can’t keep it up, but it sure is a good start, and a positive endorsement for the basic idea).

Terry

Using Investors Business Daily to Create an Options Strategy

IBD publishes a list which it calls its Top 50. It consists of companies which have a positive momentum. Our idea is to check this list for companies that we particularly like for fundamental reasons besides the momentum factor. Once we have picked a few favorites, we make a bet using options that will make a nice gain if the stock stays at least flat for the next 45 – 60 days. In most cases, the stock can actually fall a little bit and we will still make our maximum gain.

The first 4 companies we selected from IBD’s Top50 list were . . .

February 5, 2017

An Update on Our Last Trade and a New One on AAPL

About a month ago, I suggested an options spread on Aetna (AET) that made a profit of 23% after commissions in two weeks. It worked out as we had hoped. Then, two weeks ago, I suggested another play on AET which would make 40% in two weeks (ending last Friday) if AET ended up at any price between $113 and $131. The stock ended up at $122.50 on Friday, and those of us who made this trade are celebrating out 40% victory. (See the last blog post for the details on this trade.)

Today, I am suggesting a similar trade on Apple (AAPL). It offers a lower potential gain, but the stock can fall in price by about $9 and the gain will still come your way.

Terry

An Update on Our Last Trade and a New One on AAPL

This trade on APPL will only yield about 30% after commissions, and you have to wait six months to get it, but the stock can fall over $8 during that time, and you would still make your 30%.

January 20, 2017

Another Interesting Short-Term Play on Aetna (AET)

Ten days ago, I sent you a note showing how you could make 23% on an options spread on Aetna (AET) if the stock closed at any price above $118 today. Back then, it was trading at $122.67. The day is not yet over right now, but AET is trading at $122 with an hour to go until closing, so it seems safe to say that the 23% will be enjoyed by everyone who placed the trade.

Today, I would like to suggest another trade on AET that will end two weeks from today. It will make 40% on . . .

Making 36%

Making 36% – A Duffer's Guide to Breaking Par in the Market Every Year in Good Years and Bad

This book may not improve your golf game, but it might change your financial situation so that you will have more time for the greens and fairways (and sometimes the woods).

Learn why Dr. Allen believes that the 10K Strategy is less risky than owning stocks or mutual funds, and why it is especially appropriate for your IRA.

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