Why should Covered Writes be Illegal?
Now that I have your attention, why the dramatic title? Let’s start with a discussion of what covered writes are , then lets get into a discussion on a better alternative. Covered Write example: Buy 100 shares XYZ at $90 and sell 1 August 95 Call at $1. Your generally buying stock and selling an out-of-the money call against the long stock. Why would someone do this versus just buying the stock? Extra Income. As long as the stock doesn’t go up too much over a designated duration, you can make money on the stock appreciating and also some additional income from the call your selling , as long as the stock doesn’t appreciate past the short strike. What’s the problem with this trade? Cost! In a retirement account, you would have to put up the full value of the stock minus the premium of the short call. In this case, you would pay $9000 for 100 shares of stock minus the $100 premium from the short call, or $8900. What is a reasonable monthly yield on this type of strategy? About 1%. Is that bad? It’s not horrible, but for the risk and capital you have to put up, […]