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Writing Options

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PostPosted: Sat Jan 15, 2005 1:54 pm    Post subject: Writing Options Reply with quote

There are many ways to make gains in the stock market. I believe, the best way is to wait for excellent trading opportunities, which always eventually show up. The return to risk ratio is important. Risk can be measured by how much money is at risk, volatility, and uncertainty. The most that can be lost is 100% of what's at risk. Both volatility and uncertainty have positive correlations with risk.

Waiting for excellent trading opportunities (e.g. when the oscillators, which are reliable indicators, reach rare extremes) is an efficient way to trade. Also, risking little to make lots or losing little on a stock that has excellent potential to rise or fall big is an important trading concept. These ideas can be used for both small and large accounts.

However, with a large account, including a 401(k) and IRA, income can be generated weekly or monthly, e.g. by managing a portfolio or writing options. I show how to optimize option and stock portfolios, throughout the trading day. So, I'll talk about writing options.

Covered call writing is when a stock is bought and options are written (i.e. sold) for the number of shares that was bought. The best stock that can be found should be bought, since the top priority is to own the highest quality stock at an undervalued price, and writing covered calls is secondary.

Writing next month out-of-the money calls may be best, since you want to generate income without having the stock "called away," and if the stock is called away, money is made on both the appreciation of the stock and the income from writing calls. With next month out-of-the money calls, income may be generated each month.

So, for example, if C (Citigroup) at 46 is the best stock that can be found, and a long-term hold, then 100 shares of C can be bought at $4,600, and one contract of C next month 50 calls may be sold (i.e. created) for $250 (or $0.25 per option).

If C stays below roughly 50 over the next month, then the calls will not be exercised and a $250 gain is made for one month. If C rises enough above 50, then C will be sold at $5,000 and the $250 gain is kept. If C stays roughly below 50 for months (e.g. on day of expiration), then calls can be written each month. If C is called away, then the cash can be used to find another "best" long-term hold.

If the market crashes, and C falls sharply e.g. to 41, then next month 45 calls may be sold. C was originally bought, because it was the highest quality stock and a long-term hold.

However, there are risks, e.g. if the fundamentals change and the stock should be sold. There are also opportunity costs, e.g. if C rises to 55 and you're obligated to sell at 50.
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