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Investing With Options

Become a Better Options Trader

Writing Covered Calls in an Extended Market

January 4, 2011 By Steven Place

It hurts, doesn't it?

You stare at your trading screen, hilariously underinvested, in a market that won't pullback.

So here you sit, hair slightly grayer, with your brokerage account open-- stuck between a rock and a hard place.

Do you go ahead and load up and risk a pullback, or continue to sit on your hands as everyone else has all the fun?

Luckily - options trading gives you an out.

Profit and Loss of a Covered Call

Writing covered calls.

Covered calls are a kind of option trading strategy that reduce the cost of a position by "writing" a call against long stock.

By selling the call, you get the obligation to sell stock at the strike price of the option.

There are variations of covered calls that you can use to get involved with the market, but with lower initial risk.

If you want to write covered calls in an extended market, here are some option trading tips:

  1. Go In the Money. There's always a tradeoff with risk, reward, and probabilities. Instead of choosing an out of the money covered call, sell 1 strike in the money. You will receive less potential gains, but your directional exposure will be reduced and your basis will be a little lower.
  2. Sell Out of the Money Puts. This is the exact same risk profile as a covered call, but if it's on a margined account, it will keep cash on the sidelines if you need to deploy quick hedges.
  3. Go further out in time. The closer you are to options expiration, the less extrinsic value you will receive, and you will have higher directional exposure. If you choose a month that is further out in time, you can reduce your cost further and keep your risk low.
  4. Collar up. If the options volatility skew is not steep, you can purchase puts to completely limit your downside.

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