How to boost your stock returns while lowering your risk
Below is a MRR and PLR article in category Finance -> subcategory Stock Market.
How to Boost Your Stock Returns While Lowering Your Risk
Summary
Covered Call Writing is a conservative stock options strategy designed to reduce risk and increase income. It involves specific types of options contracts to offer potential rewards while managing risk.
Understanding Covered Call Writing
Covered Call Writing is a low-risk options strategy used to enhance income from stock investments. Stock options are contracts allowing you to buy or sell shares at a predetermined price. While there are eight types of options contracts, our focus here is on Covered Call Writing.
How the Strategy Works
Imagine it's August and you've purchased 300 shares of XYZ stock at $48 each. XYZ offers a quarterly dividend of 50 cents per share, yielding 4.2% annually if the stock price remains stable.
Simultaneously, you decide to engage in Covered Call Writing. This involves "writing three January 50 Calls," allowing someone else to buy your stock at $50 per share before the third Friday of January. Each contract covers 100 shares, hence three contracts. Buyers pay you a "premium" of $3.50 per share, totaling $1,050. This premium fluctuates based on time until expiration and the difference between the current and "strike" price ($50 in this scenario).
Potential Outcomes and Advantages
Two outcomes exist: the contract is exercised, or it expires worthless in January. Regardless, you keep the $1,050 premium. Key benefits include:
1. Establishing a profitable selling price upfront; ensuring a profit if exercised.
2. Reducing effective purchase cost through the premium, thereby lowering risk.
3. Increasing your annual yield beyond just dividends.
Considerations and Risks
However, Covered Call Writing limits potential profits. Regardless of stock price increases, you cannot sell above $50. To counteract this, you might repurchase the option if you anticipate a significant price rise.
Additionally, this strategy doesn't protect against stock price drops. If XYZ falls to $25, your option remains unexercised. To mitigate losses, consider buying a "January 45 put" to sell your stock at $45, offering downside protection.
Choosing the Right Stocks
Due to potential price declines, select high-quality, blue-chip stocks that align with your budget. Look for stability, strong fundamentals, high dividends, and growth potential.
Covered Call Writing isn't a reason to purchase stocks, but it can be beneficial if you already hold them. Before starting, it's essential to read "Characteristics and Risk of Standardized Options," published by the Options Clearing Corporation. This resource is available through brokers or financial advisors.
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