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The 6-Week Options Trading Kickstarter: Covered Calls

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Steve Smith breaks down a popular options strategy.

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In IBM's case, a $0.90 dividend payment is scheduled for the holding period prior to expiration. Investors long IBM stock would collect that $0.90 dividend, extending the profit on the covered call transaction to $4.90 -- exactly the same as the $4.90 profit on the short put.

Another misleading notion is the concept of calculating annual returns based on selling calls on a 30- or 60-day cycle. Let's assume that with IBM, one can garner a 3% return on an ATM option with 60 days until expiration. One should not assume this a repeatable event six times per year under the assumption that you'll earn 18%, or 19.7% with dividend, over the next 12 months. It is highly unlikely that the stock will remain flat for a year. The stock will either be called away or you'll have to adjust the strikes up or down mid- expiration, which will cut into returns.

Since the possibility of assignment is central to this strategy, covered calls make more sense for investors who view assignment as a positive outcome. Because covered-call writers can select their own exit price, assignment can be seen as success; after all, the target price was realized and should only utilized by those willing to part with the shares.

Here is a complete schedule for the 6-Week Options Trading Kickstarter. I recommend starting at the beginning if you're new to options:

1. What Are Options, and Why Should We Care About Them?
2. Option Pricing Basics
3. Meet the Greeks
4. How to use Options: Three Basic Principles
5. Covered Calls
6. Hedging, Portfolio Protection, and Avoiding Disaster

Twitter: @steve13smith

For more from Steve Smith, take a FREE 14-day trial to OptionSmith and get his specific options trades emailed to you along with exclusive access to his full portfolio. Learn more.
No positions in stocks mentioned.

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