12 Tips for Writing Covered Calls

Learn how to make the most of the options you write

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12 Tips for Writing Covered Calls

#8 – Select High-Yield Dividend Stocks

A final consideration in the selection of which playable stocks should fill your portfolio is the yield of that stock. Again, remember, our objective — to maximize the flow of income per month. Dividends, of course, would be part of that income flow.

Therefore, the option writer should not only look at what kind of a premium he is going to obtain from writing options against their stock, but also at the dividend of that stock. They should add those dividends to the returns they will receive from other option writing premiums.

#9 – Select Options That Have the Maximum Monthly Income Flow

This is critical. In measuring the income generated by an option, the only thing that we can consider is the time value (or premium value) of that option. (More on this in a minute.)

The intrinsic value of the option should not be considered in this analysis. You should only consider the intrinsic value of an option when you are attempting to provide some downside protection, but are not looking for actual income generation from that portion of the option.

#10 -The Secret Advantage of Option Writing

The secret advantage of option writing is that you can enter trades where you have a very high probability of winning no matter what the market, a stock or a futures contract does. In fact, you can sometimes enter a trade that has a 99% chance of winning. In a sense, at times, they are giving money away on the exchanges.

Why?

The option writer usually wins if the underlying instrument moves in the direction you expect, stays still or moves against you very slowly. The only time the option writer gets hurt is when the underlying instrument makes a large, fast move against you. The disadvantage to the option writer is the chance of a big loss, for you face unlimited risk.

#11 – The Second Secret For Option Writers

You have probably discovered the second secret advantage for option writers: time.

You should never hold options in the last month before expiration. But that’s good news for option writers. Only write options that have a small amount of time before they expire. For us, that means we should write options that have less than one month before expiration and avoid writing options that have more than two months before expiration.

Option premiums collapse during the last month to the advantage of the writer. Your goal as a writer is to stay in an option position for as short a period of time as possible. The more time you give the position, the more chance you have to get bitten.

#12 – Generating Better Returns From Covered Call Writing

Sometimes you’ll find an overpriced call whose premium is a much higher percentage of the share price in stocks under $15.

However, don’t buy a low-priced stock just to write a high-priced call against it. Make sure it is a stock that you want to own or you may end up with stocks whose option premiums will not offset any losses in share price.

I’ve created some really attractive risk-reward plays using this strategy. For example, in 2001, I bought 100 shares of Rambus (NASDAQ: RMBS) at $16 and sold a Jan 2003 25 Call at $8.

The premium paid for 50% of the stock ($16 – $8 = $8), so my total cost and risk on the position was only $8. So, my maximum profit was $17 (%25 minus the cost of the stock at $8), which meant a return of more than 200%.

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Article printed from InvestorPlace Media, http://investorplace.com/2010/12/writing-covered-calls/.

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