Secret 50THE HIDDEN RISK OF COVERED CALL WRITING
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Covered call writing is an extremely popular form of option
writing, but there is a hidden disadvantage. When you write (sell)
a call against a stock that you own, you are capping the profit or
upside gain, yet you still have all the downside risk. That is why it
is so important to roll out of a call position if the stock price
moves across the strike price. Your stop-loss should always be set
very close to the strike price.
Also, writing a covered call will not protect your downside.
It may offset a point or two of loss, but not much more. If your
stock position looks vulnerable, sell the stock or do a collar (sell
a call and buy a put); don’t write covered calls. Some studies suggest
that in the longer term, call writing does not increase your
returns, but does neutralize some of the short term risk and
volatility of your portfolio.
Covered call writing is an extremely popular form of option
writing, but there is a hidden disadvantage. When you write (sell)
a call against a stock that you own, you are capping the profit or
upside gain, yet you still have all the downside risk. That is why it
is so important to roll out of a call position if the stock price
moves across the strike price. Your stop-loss should always be set
very close to the strike price.
Also, writing a covered call will not protect your downside.
It may offset a point or two of loss, but not much more. If your
stock position looks vulnerable, sell the stock or do a collar (sell
a call and buy a put); don’t write covered calls. Some studies suggest
that in the longer term, call writing does not increase your
returns, but does neutralize some of the short term risk and
volatility of your portfolio.