No. of Recommendations: 8
There are 4 price quadrants: up/down & a little/a lot.
Both littles are a wash.
In up a lot, your gain is capped, you miss out on all the gain past the strike.
In down a lot, you fully participate in the loss. This is infrequent, but gives you a large loss.
If you continually write covered calls then the law of large numbers says you will sometimes hit the down a lot quadrant.
In order to win at covered calls you have to have a strategy to avoid the down a lot times. And preferably also don't write CCs in the up a lot times
The four cases are clear, though I think of it slightly differently: by comparing covered calls to a long stock portfolio with the same equities. You're better off with covered calls versus plain stock in three of the four cases: the price is up a little, down a little, or down a lot during your option interval. (you lose in that interval if the stock is down a lot, but you lose less than you would have with plain stock) Only in the "up a lot" quadrant would you have been better off with plain stock rather than covered calls.
But...few stocks go "up a lot" every quarter. It's a pretty infrequent thing, for most stocks. So, though a covered call might well do worse than plain stock in any given time interval, the odds of a covered call strategy doing better than a long stock strategy with the same underlying are reasonably good when repeated over time. That's assuming this is done with a bit of prudence...not writing calls when a stock is cheap and arguably due for a big jump. Not writing calls when the VIX is under 12 meaning selling any kind of option is probably not remunerative enough to be worth bothering. And picking an appropriate underlying stock that isn't wildly unpredictable or wildly hard to value.
It's also best in a tax sheltered account, as you'll sometimes lose your stock and have to buy it back. You don't want to *avoid* the stock being called away: it's not a bad thing. That means you're picking strikes that are too high to be worth bothering with.
Jim
