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Covered Call


 
  Description
     Writing Covered Call is the most basic of income strategies, yet it is also highly effective
     and can be used by novices and experts alike.
       The concept is that in owning the stock, you then sell an Out of the Money call
     option on a monthly basis as a means of collecting rent (or a dividend) while you
     own the stock.
       If the stock rises above the call strike, you will be exercised, and the stock will be
     sold . but you make a profit anyway. (You are covered because you own the stock
     in the first place.) If the stock remains static, then you?re better off because you col-
     lected the call premium. If the stock falls, you have the cushion of the call premium
     you collected.
       On occasion, its attractive to sell an In the Money or At the Money call while you
     already own the stock. In such cases, the premium you collect will he higher. as will
     the likelihood of exercise, meaning you?ll end up delivering the stock at the strike
     price of the sold call.
  
P/L Profile

        
 
 Steps to Trading a Covered Call
 
     1.  Buy (or own) the stock.
 
     2.  Sell calls one or two strike prices out of the money  (i.e., calls with strike
         prices one or two strikes price higher than the stock).
 
         if the stock is purchased smultaneously with writng the call contract, the
         strategy is commonly referred to as a "buy-write".
 
         Generally, only sell the calls on a monthly basis. In this way you will cap-
         ture more in premiums over several months, provided you are not exer-
         cised. Selling premium every month will net you more over a period of
         time than selling premium a long way out. Remember that whenever you                  
         are selling options premium time decay works in your favor. Time decay is
         at its fastest rate in the last 20 trading days (i.e. the last month), so when
         you sell option premiums, it is best to sell them with a month left, and do it
         again the following month.
 
         Remember that your maximum gain is capped when the stock reaches the
          level of the call?s strike price.
 
        If trading US. stocks and options you will be required to buy (or be long
          in) 100 shares for every options contract that you sell.
 
        Steps In
 
        1  Some traders prefer to select stocks between $10.00 and $50.00, considering
           that above $50.00, it would be expensive to buy the stock. Ultimately its
           what you feel comfortable with.
        2  Try to ensure that the trend is upward or rangebound and identify a clear
           area of support.
 
        Steps Out
 

        1 if the stock closes above the strike at expiration, you will be exercised. You
          will deLiver the stock at the strike price, while having profited from both
          the option premium you received and the uplift in stock price to reach the
          strike price. Exercise is automnatic.
 
        2  If the stock remains below the strike but above your stop loss, let the call
          expire worthless and keep the entire premium. If you like, you can then
          write another call for the following month.
 
        3  If the stock falls below your stop loss, then either sell the stock (if youre
          approved for naked call writing) or reverse the entire position (the call will
          be cheap to buy back).
 
 
 Outlook
       with a Covered Call, your outlook is neutral to bullish. You expect a steady
        rise.




     Example
     XYZ is trading at $28.20 on February 25, 2006.
 
     Buy the stock for $28.20.
 
     Sell the March 30, 2006 strike call for $0.90.
     You Pay              Stock price - call premium
                          28.20 - 0.90 = 27.30
     Maximum Risk         Stock price - call premium
                          28.20 - 0.90 = 27.30
                          Maximum risk of $27.30 is 100% of your total cost
                          here

     Maximum Reward       Limited to the call premium received plus the call
                          strike less the stcck price paid
                          0.90 + 30.00 - 28.20 = 2.70

     Breakeven            Stock price - call premium received
                          28.20 - 0.90 = 27.30
     Initial Cash Yield
     (Also Cushion)       3.19%            

     Maximum Yield if Exercised     9.57% (if the stock reaches $30.00 at expiration).

	
	



 
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