• Investment World
• eWorld
• Catalyst
• Mentor
• Life
• Canvas
• Praxis
• Urban Pulse
• Brand Quest

D. Murali

WHEN you sit at a restaurant table, and the menu card is actually a big bound volume, you lose your appetite. Ditto with TV surfing when your remote can travel up to 99 channels or more. Too many options do pose problems. But ask investors, they'd say that with options problems are too many.

That is because "investors know little about options and view the instruments as too risky to suit their objectives," write Richard Lehman and Lawrence G. McMillan in their book, New Insights on Writing Covered Call Options, published by Vision Books (visionbk@vsnl.com).

To get you interested, the preface begins thus: "Covered call writing is perhaps the most widely accessible option strategy. It can be utilised by any stock owner and does not require huge minimums, margin accounts, or advanced theoretical analysis." So, just the very things you were afraid of are not there. "It can be practised in a retirement account as well as in investment or speculative accounts." Or, even from your beach resort in that special place of yours under the sun. "However, in the universe of all stock owners, it is a strategy that to date, at least, has been practised by only a devoted few." Oh, no, that can start a gold rush. There is more bait: "The investment landscape that we can expect over the next several years will quite likely be ideal for covered call writing." Yet, don't assume that covered writing will make money in all markets, because "there is considerable downside risk in the strategy", though that risk is "less than the risk of owning stock outright."

In short and in simple street language: "Covered call writing will outperform plain-vanilla stock ownership during a period of declining stock prices." That deserves a chocolate-layered-nutty scoop to celebrate yourself as you read on.

Now, wait. To be a call writer, your mindset has to change. "You must come to grips with the notion that you will have ongoing but brief affairs with stocks, and never marry one." If that goes against your grain, there is a way out: run two tracks. "It is fine to invest in stocks for the long term, and it's fine to implement covered call writing — as long as you keep the two strategies separate in your mind as opposed to trying to combine them."

I can hear that odd murmur about being weak in math. "You do not need a doctorate in mathematics to master the concept of covered writing, but you do need to understand the characteristics of time-decaying financial asset and be familiar with the rules and terminology involved," state the authors. "Everyone has the brainpower to follow the stock market. If you made it through fifth-grade math, you can do it," is a Peter Lynch quote on the subject. Only, don't tell your analyst.

Right, is it not time to define covered call writing? It consists of selling call options on stock whose shares you hold. An option is a contract representing the right, for a specified term, to buy or sell a specified security at a specified price; and it can be `put' for sell or `call' for buy. Underlying security is the one that an option gives its buyer the right to buy or sell; expiration is the date when the terms of an option contract terminate; and strike price is the price at which the underlying security can be purchased or sold. Options are called derivatives because their value is derived from the underlying security.

So, that covers a few basics, but what is `covered'? Opposite of `naked'. And the difference depends on whether you own the underlying stock when you write a call option.

A book that strips covered options bare enough for you to write all over. Write what? Money!

BookValue@TheHindu.co.in

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Avery India: Accept

Copyright © 2004, The Hindu Business Line. Republication or redissemination of the contents of this screen are expressly prohibited without the written consent of The Hindu Business Line