I had an interesting conversation with my Dad today about trading. He started trading grain futures at the Mid-America Exchange (MIDAM) back in the early 1990s after he sold his machine shop and took an early retirement. Eurodollars, Sugar, Soybeans, Corn. You name it, hes traded it. But I keep telling him that with futures contracts you have to be precise. Either it goes up and you make money; or it goes down and you lose money. Its just that simple.
But using options, especially covered call writing, I tell him, Dad, you can be wrong and still make money. You can buy a stock like Nucor or IBM, or a futures contract like gold or soybeans and if you sell an at-themoney or an in-the-money call option against the trade, the odds are still in your favor to make money. If it goes down a little you still make money; if it goes up you make money; if it stays exactly the same you make money. You just have to be able to hit the side of a barn.
Once you make the switch from being a stock or option buyer to becoming an option seller, its like moving from one side of the blackjack table to the other. You become the casino house rather than a mark sitting at the table placing a bet.
Frankly, I think its easier to make money using covered calls that it is sitting at a blackjack or craps table. But its not as exciting and youre certainly not going to hit the big one initiating covered call writes. But the odds are certainly in your favor.
Each casino game has a pre-determined mathematical edge the house relies on to gain an advantage over their customers. The casino gets hurt when too many people hit the jackpot or when someone is counting cards and gains an unfair advantage against the house. Maybe its a magnetic pinky ring to induce the slot machine to pay out more often on a each pull of the one-armed bandit.
Casinos are like insurance companies too. They earn a lot of money collecting premiums. (wagers) Insurance companies get hurt when too many hurricanes or wildfires hit an area and they have to compensate the policy holders. Your monthly premium is an asset to them. When they pay a claim, its a liability. If the assets are greater than liabilities its a profitable game. Ive been paying home owners insurance for 23 years and have never made a claim.
So it is with covered call writing, you never hit a jackpot but rather you collect a statistical edge.
Month after month; year after year; up market or down; on average its 1 % to 3% a month per stock or ETF according to the Chicago Board Options Exchange. Slow and steady wins the race. Once in a while well have a tornado hit our accounts like we witnessed over the last 12 months. But the accounts that sold call options are in much better shape than those that didnt, therefore our accounts will recover sooner rather than later.
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As an FYI, every covered write I initiated in my personal accounts which had an expiration date of May 16th, 2009 was successfully closed out or assigned today. This means I: received the full rate-of-return anticipated, minus commissions and fees, gave the stock back to the call buyer which is fine with me and I
am sitting on some extra cash, ready for re-investment.
Good Luck.
On second thought, make that Good Edge