| An options strategy called Covered Call Writing is a | | | | a profit; |
| conservative strategy designed to reduce risk and | | | | 2. You reduce risk because premium in effect |
| increase income when investing in stocks. Briefly | | | | reduces the price you paid for the stock; |
| stated, stock options are contracts in which you buy | | | | 3. Your annual yield is boosted far above that of the |
| or sell the right to buy or sell. Although there are | | | | dividend alone. |
| eight types of options contracts, we're interested | | | | However, there are other considerations. For one, |
| here in low-risk "Covered Call Writing." | | | | you are limiting your potential profits. No matter how |
| Here's how it works: Say it's August and you buy | | | | high the stock rises, you won't sell for more than |
| 300 shares of XYZ stock at the price of $48 per | | | | $50. You can solve this problem by buying your |
| share. XYZ pays a quarterly dividend of 50 cents per | | | | option back, in effect canceling it out. You would do |
| share. Therefore, if the price never moves, you'll earn | | | | this if you later think the stock will dramatically rise |
| 4.2% per year. | | | | and you don't want to miss the gains to be made. |
| At the same time, you would participate in Covered | | | | Also, you have not reduced the risk that your stock |
| Call Writing. To do so, you, you would "write three | | | | may drop in price. The only certainty is, should XYZ |
| January 50 Calls." This means you are selling | | | | drop $25, your option will not be exercised - a small |
| ("writing") the right for someone else to buy the | | | | consolation. To protect yourself, you may "buy a |
| stock from you (they "call" it away) between now | | | | January 45 put" giving you the right to sell your |
| and the third Friday of January at the specified price | | | | stock for $45. This is the opposite of what we've |
| of $50. (All contracts expire the third Friday of the | | | | reviewed here, and is designed to minimize losses, |
| month.) | | | | rather than protect gains. |
| Each contract represents 100 shares, hence three | | | | Because of the potential for price drops, you should |
| contracts. The buyers pay you a fee (called a | | | | choose a high quality, blue-chip stock that fits your |
| "premium") of $3.5 per share, or $1,050. (The | | | | budget, an which offers a stable trading range, solid |
| premium is based on the amount of time until | | | | fundamental, high dividends, and good growth |
| expiration and the spread between the current price | | | | potential. |
| and the "strike price," in this case $50. Therefore, the | | | | Covered Call Writing is not a reason to own stocks, |
| premium changes constantly.) | | | | but the strategy might be of help if you already own |
| Assuming you don't cancel, only two things can | | | | them. Prior to opening an account, you must receive |
| happen next: The contract will get exercised or it will | | | | and urged to read "Characteristics and Risk of |
| expire worthless in January. Either way, you keep the | | | | Standardized Options," which is published by the |
| $1,050. Clearly, this strategy can yield big rewards. | | | | Options Clearing Corporation in cooperation with |
| Among the advantages are: | | | | NASD and all major U.S. stock exchanges. The |
| 1. You are establishing a profitable sell price the day | | | | booklet is available from any broker or financial |
| you buy the stock. If exercised, you are guaranteed | | | | advisor. |