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12 Tips for Writing Covered Calls

Learn how to make the most of the options you write

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#4 – Diversify Your Portfolio

The wise covered option writer will always have a good range of common stocks in his portfolio. This diversity greatly diminishes risk.

If you have only one position and the stock dives downward in price, your performance will suffer, as you would not be able to write options fast enough to protect the total downside risk.

To smooth out the peaks and troughs of the stocks that are being held in your portfolio, attempt to hold at least four positions in different industries — this number has been academically proven to provide good diversity.

#5 – Favor Low-Price Stocks

Low-priced stocks, such as $10, $15 or $20 a share, tend to have higher premiums per the value of that stock as compared to stocks that are selling for around $100 or more per share.

Commissions are another area in which the writer of low-price stocks has an advantage. If you use your funds to purchase 1,000 shares of ABC at $10, rather than 100 shares of XYZ at $100, you can reduce the commission costs of writing options because you now can work with 10 options, rather than one.

#6 – Buy Stocks on Margin

When you begin writing options, set aside a sum that you will use to purchase the common stock that you will be writing options against. If you are aggressive, you should attempt to get the maximum leverage from your investment. If you have $20,000 to invest in covered option writing, you should be purchasing as much stock as you possibly can with that money, even if you have to buy stock on margin (borrow money from the brokerage firm to buy stock).

The going interest rate for borrowing money to buy stock currently runs 3% to 8%. But by following the guidelines I have provided, you will generate better than 10% returns from writing options, making marginal stock profitable. Thus, the option writer will buy as much stock, or merchandise, as he can on margin.

#7 – Cash in Your Account

Another great advantage of covered option writing is that when you write options, you receive the premium from that option back immediately in the form of cash, which goes directly into your account, and can help to finance the purchase of more stocks.

As you continue to generate more and more premium from writing covered calls, this premium should be used to reinvest and obtain more and more stock, and at the same time, make more margin available to purchase additional stock. By holding a philosophy of expansion, you will obtain an attractive return on your investments and see your portfolio grow rapidly.

Article printed from InvestorPlace Media,

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