Why Our Strategy Works
The basic premise of our strategy is that as option sellers we give up some of the
possible long-term gains of our stocks in order to greatly improve the probability of getting
our targeted short-term return. Our typical holding period is less than two
months. If a bear market ensues, we're not locked into it for long.
We conservatively target a return of 12% to 18% per year, depending
on market conditions. In
2006 we made an annualized return of 19% on the 51 positions we wrote, beating
the S&P 500 while taking less risk. In 2007 we made 26.8%. In fact,
since we became a separate service in 2004, we've beaten the major averages
every year, always with considerably less risk. (Prior to 2004,
covered call writing was a successful part of my regular stock
newsletter, Insiders Plus.)
"88.2% of all our positions have closed profitably."
Though we cannot promise
that kind of return every year, as of this writing (March 2008), 88.2% of our
positions have closed profitably and average an annualized return of 17.1%.
Moreover, I expect returns on option writing to tend higher than usual for the next 3 to 5 years, due to the highly
speculative fever in the market, which brings higher option prices.
It is also important to understand that the risk undertaken by a writer of covered calls is
always less than the risk of owning stocks outright. That’s because after collecting the premium
on the calls we’ve written, we own stocks at a net cost that is below their market price. Therefore, we
have the entire collected premium as a buffer between us and a loss.
Furthermore, in uncertain markets we write mostly "in-the-money" calls
for added protection. (Please click on the Covered Call Boot Camp link,
above, for an explanation of this or any other term you don't understand.)
We typically write our positions while having downside protection in the
10% range. Most market corrections don't exceed 7%.
"We conservatively target a return of 12% to 18% per year.
In 2007 we made an annualized return of 26.8%."
It sounds almost too good to be true. I assure you, it is true, but here’s the "catch." In order to make that
safe return of 17% or 19% and have that big cushion of safety, we had to give up the theoretically infinite upside potential
of owning our stocks. Some buyers of our calls make more money on a single
trade than we do. But so what?
We almost always get our targeted return. Why should we begrudge someone a win-win
situation? Furthermore, on average we do much better than the call buyers, and with much less risk.
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