- The sale of covered call options involves the purchase of undervalued shares (or indexes) offering good growth potential.
- Calls on these shares are then sold at a strike price higher than the current price. The premium paid provides a cushion if the shares fall, but purchase of the option limits potential capital gains.
- If calls have not been exercised by their expiration date and the shares still offer good growth potential, new calls can be sold at a strike price based on the new value of the underlying shares.
- Example for July 2009:
- Purchase of 200 shares of Agrium (agriculture—AGU) at $50 each. Cost: $10,000.
- Sale of 200 call options expiring in one year with the bond to sell them at $60 (a potential 20% gain for the year). Premium of $6 per share ($1,200 in all).
- If, after one year, AGU shares are trading at less than $60, we could sell call options again if we still like the stock. If it is trading above $60, the call will be exercised and we will sell them at $60 each.
In this case, the annual return would have been 32% if AGU had been purchased at $60 at the end of the year. If AGU had grown 0% for the period, the strategy would still have earned 12% from the premiums paid. This 12% would also help to compensate for any drop in share price. In other returns, the return is optimized for given risk tolerance.
Globevest Capital makes every effort to manage risk for all portfolios and keep them healthy, whatever their underlying strategy.
