Houghton and Atkeson

   

The hedge portion of this trade is to effectively lower the cost of your stock by collecting option premium. If your stock is not called away -- that is, the holder of the option (i.e., an individual who "bought to open" a call option with the same strike price of the option you sold) does not exercise the option -- because of appreciation through the strike price, it helps to juice up your portfolio returns.

Think of it this way: In this example, you are holding a profitable position in AAPL and enjoyed gains even when the stock was trading flat. It doesn't matter how you're making gains -- just as long as you're making them! Trading options can generate returns faster and more frequently than simply buying and holding the stock by itself.

However, there are risks to selling covered calls. First, the stock could drop way down and the premium you collect is peanuts relative to your loss in the equity. Or, if the stock rips up and through the strike price in the contract you sold, you could lose the stock and potential upside. Having the stock called away can also trigger unwanted tax consequences.

During the past 10 years, selling covered calls became very popular, as implied volatility was typically priced higher than actual volatility. In the past year, however, actual volatility levels have increased making this strategy less attractive.

A STEP IN THE RIGHT DIRECTION

The third reason why people trade options is to leverage a directional bet. Big Money Options is focused on this type of options activity. We look for trades where the options investor believes he has information that is highly directional in nature and where he is seeking the maximum leverage and return on his investment.

(Check out some of the recent items that have hit our trading radar -- and see what's new each week at absolutely no cost to you -- by clicking here.)

Trading options allows investors to greatly extend a small amount of capital (relative to buying the underlying stock) and earn hundreds, if not thousands, of percentage returns.

Michael Shulman

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