THE OBJECTIVE OF AN OUT-OF-THE-MONEY CALL WRITING STRATEGY IS TO CAPTURE CASH RETURNS (POINTS) IN SHORT TIME FRAMES (1-3 MONTH INCREMENTS), WHICH, WHEN COMBINED WITH THE RECEIPT OF CASH DIVIDENDS AND MODERATE PRICE APPRECIATION, WILL RESULT IN SUPERIOR ANNUALIZED INVESTMENT RETURNS.
Expected Duration of Call Options: 45 to 75 days.
Beta (volatility) of the underlying stock: a major element of the strategy is that the strategy seeks to minimize risk to the “principal” of the portfolio. This element is especially pertinent in downward trending market environments. Generally, the strategy will include securities that have lower than average beta (volatility). Many of the stocks included in the strategy are in the value sector of the market. In other words, in the event of extended market downturns, the typical stock included in the strategy will likely drop less than the major market indices. When combined with the cash generated from the strategy itself, the damage caused by extended market downturns or bear markets is thereby minimized.
The risks associated with the strategy are:
1. Declines in the stocks owned by the portfolio – “bear market risk” that is inherently present with the ownership of equities.
2. The market may runaway to the upside; the call writer may participate in the rise of a stock only up to its “strike price”, and therefore, the loss is this instance is defined as lost opportunity, and not as lost dollars.
Call-writing Strategies Performance in Various Market Environments: