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chapter2/4 growth

Chapter 2

Growth

Options may be used to increase the probability of a return on an asset.

The covered call strategy consists of the purchase of a stock and a simultaneous sale of a call on that stock. The seller, or writer, of the call incurs the obligation to deliver the stock to the option buyer. Since the covered call writer owns the stock, the writer is covered against loss. The stock can be delivered to the option buyer to satisfy the obligation of writing the call. The covered call writer collects the option premium and also reaps the benefits of owning the stock such as collecting the dividend and holding voting rights, but incurs the risk against loss should the stock price decline.

The advantage of covered call writing is a more predictable flow of income. Proceeds from the sale of the call are realized immediately. The disadvantage is that potential gains from the stock position are limited. The covered call strategy works well in flat markets and is permissible in most retirement trading accounts. The stock can be purchased and the option sold in the same transaction, called a complex option trade. In a complex option trade the credit from selling the option is applied against the cost of the stock, which reduces the funds required to purchase the stock. There is also no risk of entering one trade and and then losing out on the second trade due to market movement.

 

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