Tuesday, April 12, 2011

Covered Calls: Safe, Incremental Income

We just finished the 1st quarter for 2011, and I’m looking ahead for what’s ahead in the markets. The Dow rose 6.7% this quarter, making it the best Q1 since 1999. That's an impressive gain given the uncertainty of the war in the Middle East, economic slowdown in Japan, and the threat of higher interest rates when QE2 ends in June.

What is a conservative investor to do after such a move? Pull out of equities and sit in cash for a while? Maybe, if you don't mind creating a tax event for your unrealized gains and making zero interest return in a savings account. But another choice is to protect your portfolio by using covered calls, where you sell call options against stocks you own. The benefits of covered calls are that you lower your risk and generate monthly income. The downsides are that you still have equity exposure and you're putting a cap on future upside, though less so as each call contract essentially lowers your initial position.

I've been doing covered calls for over 25 years and have had amazing success with the strategy. It’s fairly conservative, and can simulate the effect of paying you a monthly dividend. There are a variety of resources out there to educate and find opportunities, but one site I like for is Born To Sell. It’s got many unique screening features to explore 150,000 covered call possibilities, as well as crowd-sourcing feature where you can see what strategies other members are doing (social investing?!).

Finally, investing these days is tough, whatever you do, tread lightly. That said, I wanted to share what I’ve done for decades through a lot of uncertain markets, with relative safety and over time quite profitably.

1 comment:

  1. I agree on the value of writing covered calls. Once you understand the ropes, you can generate weekly or monthly income. I also use Born to Sell and it is a solid tool.