Wednesday, January 14, 2009

covered calls, limit orders, and clinics

Part 1: The Powerstroke clinic went well, we will hold our next one on March 28 at 11AM. Check the website for all the details.

Part 2: Today I wrote my first covered call option. 1 option contract is for 100 shares. I have owned 100 shares of a company for a couple months and finally got around to getting permission to trade options in my IRA. I didn't realize you could do that.

Writing covered calls is the most simple option trade. You have to own 100 shares for every 1 contract you write. I wrote an out of the money (OTM) option. You can also write in the money (ITM) options and that is sometimes worthwhile if the return and time horizon is good. Anyway. So for this dividend paying stock I am planning to hold onto indefinitely, I was paid $95 to promise someone I'd sell them the stocks at a price that was $2.50 higher than today's prices on the third Friday in February. Chances are pretty low that the stock will climb that high. If it does then my loss is the additional upside I am missing out on.

The major risk of writing covered calls is actually holding onto the stock, as it could plummet to zero. The more volatile a stock is, the higher the yield on the options, since more people are looking to hedge their positions/lock in profits etc. A less volatile stock, like Coke (KO), has less return on the options since it generally trades in a narrow band (meaning it is more predictable).

If I can keep this up for 1.5 years, the options trades will have entirely paid for the underlying stock I own. I also get to keep dividends. My plan over the next few months is to acquire 2 or 3 more blocks of 100 shares in other relatively stable dividend paying companies, and write these calls each month for an extra $300-400.

Part 3: I am playing poker tonight, since the odds are probably better than making picks in the stock market.

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