For better or worse, most investors purchase stocks with the
intent of holding their shares for an extended period of time.
We do this mainly because the media and industry professionals
have drilled into our heads, year after year, time after time,
that its best to buy and hold. The recent bull market phenomenon
also fueled this mindset because the buy and hold options
strategy worked extremely well - for a while.
Whether or the not the buy and hold options strategy is still
the most efficient way of investing remains a topic for discussion.
However, it is still the options strategy that most investors
are comfortable with and tend to follow.
The first options strategy
we will discuss is a hybrid of the
buy and hold options strategy, one that provides for better
and more consistent returns a large majority of the time when
compared to naked stock ownership alone.
When we buy a stock, there are three possible outcomes. Two
of these scenarios are generally negative and only one outcome
is generally positive. If the stock goes up, that is good. If
the stock goes down, that is bad. And if the stock stays still,
that is also a bad outcome.
To briefly recap, not only do you have a loss in opportunity
cost (the money invested in your stagnant stock could be making
you money if somewhere else) but also, you have incurred commission
costs on both the way in and way out. So, in this case, only
one of the three scenarios provides a positive return.
For the sake of description, we will identify the three potential
scenarios as the up scenario, the down scenario and the
stagnant scenario. By employing the covered call or buy-write
options strategy, you can change the outcome of the scenario
profile so you have two positive potential results instead of
Employing the covered call or buy-write options strategy,
we still have the up scenario as a positive result, but now
the stagnant scenario will also produce a positive result
since we collect a premium and the third scenario, the down
scenario will not be as negative.
Thanks to the covered call options strategy, now two of three
scenarios end in a positive result and the third has a result
that is less negative.
Lets take a closer look at the covered call options strategy
and its construction. There are two components of the covered
call options strategy, the stock component and the option component.
The stock component of this options strategy consists of a long
stock position (you own stock). The option component consists
of selling one call per every one-hundred shares of stock owned.
Remember, one option contract is worth one hundred shares of
stock. So for example, 1000 shares of stock equals 10 call contracts
or 200 shares equals 2 call contracts.
The chart below shows more examples of the proper construction
Please take special note that the ratio of stock to calls must
be exactly 100 shares to 1 option contract.
For chart below, stock price = $35.00