Australians are fond of their shares. In fact, we have the highest percentage of share owners per capita in the world, with over 54% of us owning shares. Despite this awesome statistic, very few Australians know how to really take advantage of their shares. In particular, the writing of Covered Calls, one of the greatest investment strategies ever created!
So what are Covered Calls?
First off, a call is an option. Technically, anyone who buys a call option is purchasing the right, but not the obligation to buy a parcel of shares at an agreed price, on or before a set date in the future.
For example, let’s say Telstra was trading at $6.00 and you thought that the share price was going to rise. You could purchase a $6.00 call option with a one month expiry. This option contract gives you the right to purchase 1000 Telstra shares on or before the last trading Thursday of the next month. This option will likely cost approx $0.25 per share, or approximately $250.
Now, if Telstra shares rose above $6.00 any time within the next month, say to $6.50, you could exercise your option and buy the 1000 shares at $6.00, thereby making a gain of $0.25 per share ($0.50 – $0.25 premium). That’s a profit of $250, or 100% return on your original $250 investment!
Buying call options is a popular strategy, however it is risky as the underlying shares must rise in value or you could lose the money you’ve spent to purchase the call option.
Another strategy involves being the person who sells the call option. In this case, let’s say that you owned 1,000 Telstra shares that you purchased at $6.00 and they are currently trading at $6.00.
As you own the shares, you may sell to someone else the option to buy your shares from you. You can choose the price you wish to sell at from a range of prices and you can choose the length of time the contract will exist, from one month out to twelve months.
For example, it is now November. You can sell the December $6.50 call option. This means that the person who buys the call option from you has the right, but not the obligation to purchase your 1000 Telstra shares from you on or before the last trading Thursday of December, which is Dec 21st, 2000.
For this option someone is going to pay you approx. $0.15 per share, or $150 (1000 shares x $0.15 per share) or approx. 2.5% of the value of your Telstra shares.
What you have just done is known as Writing a Covered Call.
Three things can now happen.
1. The share price can go above $6.50.
2. The share price can remain between $6.00 and
$6.50.
3. The share price can fall below $6.00.
If the share price rises above $6.50, your option will be exercised. In other words, you will be forced to sell your shares at $6.50.
You will keep the $0.15 premium paid to you originally plus you keep the $0.50 profit per share. Therefore, you will make a profit of $0.65 per share, or $650 in total, which is a return of over 10% for the month!
If the share price remains between $6.00 and $6.50, then you will not be exercised. You can keep the $0.15 premium and keep your shares! That’s a profit of 2.5% for the month and you haven’t even sold your shares! Annualised, that’s a return of 30% per annum! The best part is that you can do the same thing next month and generate more cash!
If the share price falls below $6.00 then you will not be exercised. Again, you can keep the $0.15 premium and keep your shares! However, the share price is now falling, so you are entering a loss zone. But remember, we’ve already been paid $0.15 per share, so the share price can fall to $5.85 before we start to suffer an actual loss. Again, next month we can write another call and generate some more cash.
Writing Covered Calls is one of the simplest, most profitable investment strategies available. Many people own large portfolios of shares that they have just been sitting on for years and aren’t aware of the opportunities that are available to them. What’s more, they aren’t aware of the lost opportunities available to them!
Daniel Kertcher
Platinum Pursuits
Source: http://www.ArticlePros.com/author.php?Daniel Kertcher
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