Options for Investment Clubs
February 10, 2003
The National Association of Investment Clubs (NAIC) is an organization supporting and encouraging people getting together to learn about investing and investments.
Emphasis is on education. Club members are encouraged to carefully do research before making investment decisions, buy shares in companies projected to grow earnings over the coming years, and to consider industry leaders.
The philosophy of such clubs is to continue to invest, through both bull and bear markets. The rationale is that owing good companies will prove to be profitable over time.
Many clubs have not been doing well in recent years. That is not surprising, as we have been in a bear market.
WHAT CAN A CLUB DO TO IMPROVE ITS PERFORMANCE?
By adopting the Covered Call Writing Strategy, investment clubs (as well as all investors) can accomplish these objectives:
- Use options to provide to protection against loss
- Use options to lower the cost of each stock position
- Use options to make profits more often
Let's look at how this strategy works.
Example
Current position
New trade: Sell 1 Sep 40 call for 10
- Today is Feb 10
- You own 100 shares of XYZ
- Stock price 45
You have $4,500 invested in this position, at today's price
- The option expires in 7 months, 2 weeks (Sep 19)
- Your option price is 10, so you receive $1,000
- You now have only $3,500 tied up in this investment
When expiration arrives in September, you will make the maximum profit this position allows, whenever the stock is trading over the strike price, or $40 per share. That profit is $500 because your cost is 35 and you sell for 40.
In order to make that much profit when NOT selling the call option, the stock would have to rise to 50 by expiration.
Thus you must choose:
- Do not sell the call
- The stock must climb to 50, to earn the same $500 profit
- Your profit potential is umlimited, as the stock can go higher
- Sell the call
- To earn your $500, the stock must only be avove 40
- Your profit potential is limited to that $500
1) Safety. If the stock declines in price between now and options expiration (Sep 19), you do not lose any money for the first 10 points of decline - This is the result of receiving $1,000 cash for the option.
If you do not sell the call, you lose money for any decline in the stock price
Thus, you lose money less often when using the Covered Call Writing strategy.
Profitability. Because the cost of your investment has been reduced by 10 points (from 45 to 35) you make money any time the stock is higher than 35 when expiration arrives.
If you do not sell the option, you have a profit only when the stock is higher than 45 when expiration arrives.
Thus, you pofit more often when using the Covered Call Writing strategy, although that profit is limited.
This strategy was introduced in a previous column.
This strategy is easy to learn and understand. For a basic but thorough disucssion, read The Short Book on Options : A Conservative Strategy for the Buy and Hold Investor.
To learn about our book, click here .
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