The Covered Call / Buy-Write Options Strategy

For better or worse, most investors purchase stocks with the intent of holding their shares for an extended period of time.

We do this mainly because the media and industry professionals have drilled into our heads, year after year, time after time, that it’s best to buy and hold. The recent bull market phenomenon also fueled this mindset because the ‘buy and hold’ options strategy worked extremely well - for a while.

Whether or the not the ‘buy and hold’ options strategy is still the most efficient way of investing remains a topic for discussion. However, it is still the options strategy that most investors are comfortable with and tend to follow.

The first options strategy we will discuss is a hybrid of the buy and hold options strategy, one that provides for better and more consistent returns a large majority of the time when compared to naked stock ownership alone.

When we buy a stock, there are three possible outcomes. Two of these scenarios are generally negative and only one outcome is generally positive. If the stock goes up, that is good. If the stock goes down, that is bad. And if the stock stays still, that is also a bad outcome.

To briefly recap, not only do you have a loss in opportunity cost (the money invested in your stagnant stock could be making you money if somewhere else) but also, you have incurred commission costs on both the way in and way out. So, in this case, only one of the three scenarios provides a positive return.

For the sake of description, we will identify the three potential scenarios as the “up” scenario, the “down” scenario and the “stagnant” scenario. By employing the covered call or “buy-write” options strategy, you can change the outcome of the scenario profile so you have two positive potential results instead of only one.

Employing the covered call or “buy-write” options strategy, we still have the “up” scenario as a positive result, but now the “stagnant” scenario will also produce a positive result since we collect a premium and the third scenario, the “down” scenario will not be as negative.

Thanks to the covered call options strategy, now two of three scenarios end in a positive result and the third has a result that is less negative.

Let’s take a closer look at the covered call options strategy and its construction. There are two components of the covered call options strategy, the stock component and the option component.

The stock component of this options strategy consists of a long stock position (you own stock). The option component consists of selling one call per every one-hundred shares of stock owned.

Remember, one option contract is worth one hundred shares of stock. So for example, 1000 shares of stock equals 10 call contracts or 200 shares equals 2 call contracts.

The chart below shows more examples of the proper construction of buy-writes.

Please take special note that the ratio of stock to calls must be exactly 100 shares to 1 option contract.

For chart below, stock price = $35.00