Our Call Option Strategy

July 7, 2008 | By | Reply More

SPDR Gold Trust ETF is the most actively traded call option on the CBOE only a month after the option started trading. Options in the gold ETF are allowed to trade in the US as the fund holds physical gold.

We were delighted when option trading began in our favorite precious metal investment vehicle as it will allow us to use our much favored source of added income in these uncertain times.

Ever since we began to feel that the stock market was overheating in the face of all the economic evidence that it was due a fall, we have been active in trading covered calls.

The fact that we were nearly a year premature did not alter our conviction that a safe 20% annual return on our long-term picks was the way to go.

For those who are uncertain, a covered call is the purchase of a stock in multiples of 100 shares and either simultaneously or at any time afterwards selling the option to buy those shares at a set price in the future.

Our strategy has been to purchase shares in major companies whose income is derived globally and not confined to the US or similar and sell the call up to six months ahead for a strike price that gives around a 10% profit, including the call option sale price if the option is exercised. If the shares are not called away we simply repeat the process.

Remember that the option price you get is money in your pocket whatever happens and can be added to the profit you get if you have to part with the shares. Each time you repeat the process the price you paid for the stock is effectively reduced by the price of the call option you have sold.

If th call option does not reach the strike price you should also have the consolation of keeping an interest in a sound company and receiving the dividends.

We are never unhappy if our covered call is exercised as we pocket our 10% profit in six months, sometimes less if we get our timing right. There are always plenty more fish in the sea to pick from.

Of course it can be frustrating if the call is exercised and the stock continues to soar but a bird in the hand is worth two in the bush

Two examples to give you food for thought.

We bought Alcoa at $36.17 in May and sold the July 45 call for $1.70. Fridays close was 32.78 and it is looking very unlikely that the strike price will be reached.

Conclusion: profit $170 per contract and chance to sell another call at the end of this month while in the meantime very happy to be in a company as sound as Alcoa for the long term.

If the strike price had been reached and the option exercised our profit would have been $1053.00 before charges, not far off 30% in less than four months!

Also in May we bought Energy Conversion Devices at $33.00 and sold the September 35 call for $3.90. On the call price alone we have made our target of 10% in less than five months.

The kicker here is that the price closed on Friday at $64, and has been considerably higher. If we had not sold the call we would be looking at 100% profit in the same time period.

That’s life and Mr Market, a bird in the hand, benefit of hindsight etc.etc. but unhappy we are not.

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