What are the cause of buy-write strategy or covered call strategy? Are they beneficial? These questions, in the minds of investors, have brought stampede in the world of investment.
Majority of investor purchase their stocks with the intention of holding their shares for long period of time. It is just because the professionals in the field of industry and media have put it into our minds that it is better to purchase and then hold the shares. This mindset has also been supported by recent phenomenon that the strategy of buy and hold works well.
But the final decision on whether the strategy of ‘buy and hold’ is the efficient way or not is still the topic of discussion. But still, this strategy is the one, which is found comfortable by several investors. They tend to follow the same strategy.
The first strategy is the improved form of buy and hold strategy. This buy-write strategy provides consistent and better returns with time when compared to stock ownership alone.
There are three possibilities of outcomes, while buying a stock. As concluded from discussion, one of these three outcomes is generally positive and two of the three scenarios are generally negative. Reduction in the stock or the stillness is considered bad outcome whereas the rise in stock is a good indicator.
While summarizing, we can say that it is not only that there is loss in opportunity cost but the commission costs is also incurred on the way in and the way out. Always remember that money invested in the still stock can give you better income opportunity, with some other stocks. So, it can be said that only one of the three scenarios produces a positive result.
While we reach to description, we will identify only three scenarios, which are:-
- The “down” scenario
- The “up” scenario
- The “stagnant” scenario
By employing “buy-write” strategy or the covered call, the outcome of scenario profile can have two positive outcomes, instead of only one. Now, both the “up” scenario and “stagnant” scenario will have a positive result and “down” scenario will not be so negative.
It is because of covered call strategy, two of the three scenarios get positive result with third less negative outcome.
Covered call strategy has two components- option component and stock component. The stock component includes a long stock position. The option component includes selling one call per 100 shares of stock.
When we have look over the odds, in order to decide whether it is better to sell option or buy option, there have been several studies on the topic of premium buying verses premium selling.
One of the recent studies has shown that it was 78% to 83% correct trade while selling the premium. It is a high percentage and advantageous when a good opportunity presents itself.
The fact that an option is a depreciating asset is one of the factors considered advantageous by covered call strategy. It is because its extrinsic value reaches zero at expiration. This process due to which there is dissipation in option’s extrinsic value is called time decay.
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