Sunday, February 20, 2011

Covered Call Writing Myth

According to Investopedia “When to Use a Covered Call - There are a number of reasons traders employ covered calls. The most obvious is to produce income on stock that is already in your portfolio. Others like the idea of profiting from option premium time decay, but do not like the unlimited risk of writing options uncovered. A good use of this strategy is for a stock that you might be holding and that you want to keep as a long-term hold, possibly for tax or dividend purposes. You feel that in the current market environment, the stock value is not likely to appreciate, or it might drop some. As a result, you may decide to write covered calls against your existing position.”

I think I got it – you buy a stock but you think it will go down so you keep it and collect a few bucks selling calls and if it goes down you don’t lose quite as much. It the event the stock you own goes up (remember that long term hold) well it gets taken away from precisely when you want to own it. Call me old fashioned I always thought the only reason we own stocks is because they would go up.

Here is a shocker – a talking head on BNN recently said he makes 3% a month doing covered put and call writing. Now 3% a month is 42.6% annualized! I think Weizhen Tang (the Chinese Warren Buffett) promised 1% weekly returns. In my opinion covered call writing is a great strategy for generating commissions and sometimes the client will make as much as the option trader. Can a covered call writing strategy generate 3 per cent a month? We will soon find out because BMO Financial has just launched a new Covered Call Banks ETF (ZWB). BMO doesn’t claim 3% a month but they do claim they will “provide a tax efficient yield of dividend and capital gains (and) potential to outperform broad indices” Let us follow the ZWB over the next few months  

No comments: