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Strategies & Market Trends : The Covered Calls for Dummies Thread
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To: Jon Khymn who wrote (4202)4/15/2004 6:03:56 PM
From: Dan Duchardt  Read Replies (1) of 5205
 
Any comments?

Timing is everything, even with options. You have some assumptions in your statements that may work out for you, but things can go wrong.

Suppose, as you suggest as a possibility, RMBS goes from 28 to 13, but makes a large fraction of that move in the next month. Assume it drops from 28 to 20 in the next month (not likely, but stranger things have happened) If you want to collect another $1,75 premium, you are looking at selling strike 20 or perhaps 22.50 calls and risking being called out at a loss. Assume you do it anyway, and it continues to drop to 15 the next month. Are you now willing to sell a strike 15 call to collect another $1.75? If you do, your net cost to own the shares purchased at $28 will be $28 - 3*($1.75) = $22.75, and you risk having to sell your stock for $15 and take a loss of $7.75

If you decline to risk being called out at a loss, you have to sell calls at strikes that are at or above your net cost of ownership. There is no guarantee those calls will be selling anywhere near $1.75 every month. The premiums for those calls might be so small that you would not want to sell them and miss losing out on a rally.

This is not to say that CCs are a bad strategy, but writing calls has its own set of risks that cannot be discounted by assumptions that may prove to be invalid.
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