Friday, February 19, 2010

Buy-Write Options Strategy (AKA Covered Call)

The Buy-Write Options strategy (AKA covered call) is starting to gain some attention again.  The reason it is starting to gain attention again is because it is effective at reducing the impact of a bear market on your overall portfolio value, and because it is highly effective at generating cash flow during a neutral market.  The strategy will however consistently under perform the market during a bull run.

Advantages of the Covered Call:

  • Generate Cash Flow from your long portfolio.
  • Reduce the effect of market volatility
  • Reduce your un-realized losses during a bear market.

The strategy amounts to 2 simple steps:

  1. Buy N 100 share blocks of the stock where N is some integer 1 or more. This will obviously depend on how much money you have to invest. Some stocks that trade for 5 dollars will only cost you 500 dollars per block, while other stocks like Berkshire Hathaway will cost 11,000,010.00 per 100 share block as it is trading at 110,000.10 per share at the time of this writing. Also, just for completness BRK-A does not have exchange traded options written against it.
  2. Sell N Call contracts against the stock or ETF you just purchased, where N is the number of blocks you bought. The selling of the call will generate cash (put money into your account). However, if the call expires in the money you will be forced to sell the N blocks of stock you just bought.
 The image below shows the maximum profit that the portfolio can achieve during a "bull run" which shows the significant limitations of the strategy in a bull market.

This posting is intended to wet your appetite for understanding the Buy-Write strategy.
Much greater detailed discussion is presented at:
Quantprinciple's Buy-Write/Covered Call Strategy

And of course if you like the article, please digg it:

Q. Boiler

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