If you're like most investors, you're probably looking doubtfully
at this stock market. Is it worth the risk now that many of us are
back to where we were before the 2008 crash?
Why not just take money off the table, put it in bonds and be done
Well, there's a little-known way that anyone can KEEP their stocks
AND continue to make profits even if the market makes a further
turn for the worst.
The time has come for the average investor, whether wealthy or in
the process of accumulating wealth, to consider using a powerful
investment strategy - covered calls.
Covered calls are widely used by savvy "institutional
investors"...pension funds, insurance companies, endowment funds
and some mutual funds. The strategy is little known and often
misunderstood by individual investors.
However, when using highly-liquid options on small-cap stocks or
ETFs the combined return from potential capital appreciation and
additional income you receive from covered calls can yield double
digit returns, more predictably, consistently and conservatively
than with small cap stocks or ETFs alone.
As I have stated numerous times in the past, most investors think
of options as high-risk, speculative strategies where large losses
can be incurred. While this is certainly true of some options
strategies, covered calls are more conservative than investing in
stocks or ETFs alone and most importantly, they can provide
significant protection in a down market, and can be a key component
for an investor to achieve double digit returns in a flat or slow
So I am certain that some of you are asking the question, "what is
meant by the term 'covered' anyway?"
Simply stated, it means that you own shares of the underlying
security, in our case a small cap stock or ETF that stand behind
the options. And you are selling calls against the "covered"
portion that you own.
For example, let's say that you own 1000 shares of
iShares Russell 2000 Index (
and you would like to increase your income on the IWM shares that
you own through the use of a covered call options strategy.
It is the third Friday in September (options expiration falls on
the third Friday of each month) and you start to check into the
premiums for IWM options contracts with various strike prices and
While you like IWM's long-term prospects, you think that the price
of your 1000 shares may not be higher than $5 above its current
market price of $65 at the end of the next three months.
The front month September $70 call is trading at $1 per contract.
For receiving a premium of $1 per share you decide you would be
willing to let go of your 1,000 shares of the IWM at $70 if the
price should be greater than $70 on the expiration date (in our
case September 16th).
So, from this transaction you will collect $1,000 in option income
($1 premium per share * 10 contracts * 100 shares per contract).
Annualized, the premium income at the current market price of IWM
based upon that premium and the market price of IWM. Not too
You also have the potential to realize an additional $5,000 of
capital appreciation if the price of IWM exceeds $70 per share on
the expiration date.
Now the downside. If IWM would go to, say, $73 before the
expiration date, you would probably feel pretty bad that you had
lost out on some additional capital appreciation. You would only
receive $70 per share plus you roption premium of $1, or a total of
$71 per share, so you would have missed out o receiving $2 per
share that your shares would have been worth had you done nothing
but hold them. You also have $1 per share of downside protection if
IWM's price heads south.
But, it is still possible to lose money buying IWM and using
covered calls if the price of IWM declines significantly. But, if
you are caught in a declining market like we are experiencing
today, you will ALWAYS be better off if you use covered calls on
your shares compares with just owning IWM.
Because the premium income gives you the added downside protection
that you would not otherwise have. If the market drops out and you
aren't selling covered calls, then your shares are worth less, AND
you're out the $1,000 (in our example) that you didn't collect from
selling the calls.
Just remember, when using covered calls you are no longer in the
business of trying to maximize capital appreciation on your shares.
You are now in the business of using covered calls to provide a
rate of return that will meet or exceed your objective on a
consistent and predictable basis.