Introduction to Covered Call Writing Are you tired of relying on the stock market for future gains? Have you ever realized that there are other vehicles called options, which can potentially be used to generate additional income? They can even be used as hedging devices. Options can put you in a position where you don't need a stock to appreciate in order to realize a gain. On the contrary, even if it goes down, you will be moderately hedged (If the security remains the same price you could potentially still profit from the sale of options). Now I know what your thinking, options is how your next-door neighbor blew all of their savings. Nine out of ten times you are probably right, because it involves speculative option buying, where losses can indeed be significant. On the other hand, covered options writing may be conservative and appropriate for many investors. Option writing is a strategy that attempts to deal with the following three concepts: Income, risk reduction and capital appreciation. Most investors have portfolios designed to take advantage of only one type of market direction, up. This tends to be a shortsighted and unfortunately leaves the investor at the mercy of the market. An investor's primary concern should be to increase their odds of success, especially in times of uncertainty. Option writing puts the investor in a position that they do not need the stock to appreciate to profit, and are moderately hedged on the downside. Here's a simple definition: writing a covered call consists of selling a call option, while simultaneously owning the underlining stock. An investor buys a stock and then agrees to sell the stock to someone else at a specified price (strike price). In return for this, the investor receives a premium (option price). For example, let us suppose that one decides to purchase XYZ stock at ten dollars per share. You then decide to sell an option, the March 10 calls (for example) for two dollars. For the purpose of this discussion lets assume the stock is purchased on January 2, and the option sold (covered call) is due to expire in March (options expire the third Friday of the month, lets assume for the purpose of this exercise March 21). Our transaction, which involves buying the stock at ten dollars, authorizes the buyer of the option (that we sold) to purchase XYZ stock until March 21 at ten dollars per share. The option buyer paid us two dollars per share to have that option. In Layman's terms, if the stock is above $10, the buyer of the option will exercise their right to buy the stock at $10, (and literally take the stock out of your account at $10), and if the stock is not trading above $10, they naturally have no interest in exercising their option at $10. (Each option strategy will have varying option contract prices, based on the inherent volatility of the underlying stock). The buyer of the stock at $10 is immediately hedged for $2 on the down side (which is the money they received), and has a break even of $8 dollars per share. As well, the buyer of the stock realizes the $2 gain per share a priori, and thus doesn't benefit from any stock appreciation, and most importantly does not require the stock to appreciate to realize a gain. Again, please note that the strike price ($10) is the maximum profit that you will earn at any given point. This implies that you have a predetermined selling price on the upside, and are willing to forego any potential gain over and above your stated contract price. This decision is determined at the beginning of the transaction and you will have to live with it, should the stock appreciate. Should the stock drop, the money received will of course act as a partial buffer. It should be noted and stressed, "When you sell a call on a stock that you own, the only downside risk you have involves your stock, and you would have that risk whether or not you sold a call option. The call option itself, however, presents you with no downside risk." (AMEX booklet entitled Increasing Your Income From Options, Page 3). Should the stock drop, various defensive strategies may be employed to further protect you on the downside. This is known as "rolling". In our example should the security appreciate to or above $10, you become obligated to sell at this price. If the stock is sold at $10 you will be essentially selling out the position at $12 (after incorporating the two dollar premium paid to you). If the stock does not appreciate at all and remains at the same price of purchase you will still come out ahead because the premium received represents additional funds in your account. If the stock drops to the extent of the premium received then you have essentially lost nothing (you don’t lose unless the stock depreciates below $8). The secret to successful covered call writing is to invest in quality stocks and focus on consistency, not very high returns. Investors will see high returns when their investments grow over a period of time. The covered call strategy has the ability to meet the needs of a wide variety of investors. It can be used in your IRA, Keogh margin or cash account against stock you already own or are planning on buying. If you have any questions or if you need any clarification, please don’t hesitate to contact us!! Welcome to Centrade (a division of Spencer Winston Securities), where discount meets full service. Please note this brokerage still remains a discount brokerage. All trades remain unsolicited and are the responsibility of the investor. It should be noted that options purchasing is a completely different strategy and is not suitable for all investors. Feel free to contact Ezri Shechter, at 1350 Broadway to receive option disclosure documents, and for any additional questions you might have.

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