A few thoughts about risk.  Please consider the following statements and formulate your own opinion.

•  When a stock is purchased, the investor is assuming the risk of losing some or all of the amount invested if the  stock looses value (and never recovers) or if the company goes out of business.  As long as an investor owns a stock, there is the possibility of it increasing in value over time.

• When an option is purchased by itself, the investor is assuming an even greater risk, because the option is only valid for a specified length of time.  If the underlying stock loses value, then the option to purchase that stock will also lose value.  The additional risk comes into play if the stock does not recover in value prior to the option expiring.  For this reason, the purchase of options by themselves is an extremely risky investment and cautionary statements are required.  Purchasing of options as an investment is not allowed in IRA accounts because of this risk of loss and indeed "options involve risk and are not suitable for all investors."

• An example and then a statement.  If you purchased 100 shares of a stock for $15 (net) a share, you would have invested $1,500  (100 x $15 = $1,500) in the stock position.  Now, if you sold a $15 call option against that stock and received $1 per share for the call, you would have 100 shares of stock and $100 in cash (100 x $1.00 = $100).  One of two things will happen.  Either the option will expire and you will keep the stock and the $100, or the option will be exercised and you will receive $1,500 (less commissions) for the stock, but also keep the $100 premium you received for the call option.  IF YOU DON'T DO ANYTHING, ONE OF THESE TWO EVENTS WILL HAPPEN.

Now for the statement.  Purchasing a stock is less risky then purchasing an option, but purchasing a stock and then selling a covered call     against that stock is less risky than just purchasing the stock alone.   Why?  Go back to the example.  Let's say you just purchase the same stock for $1,500.  If the company went out of business, you would lose all of your $1,500.   Now if you purchased the same stock and sold the $15 call for $100 and exactly the same thing happened, how much would you lose?  Your right! ... You would only lose $1,400 because even though the company went out of business and you lost the same $1,500 as before ... you would keep the $100 premium that you already received by selling the option.

Now for a fact - covered writing is more conservative than buying stock.  Don't just believe that ... even though it's true, take a moment and visit this link to the Chicago Board Options Exchange discussion of covered calls at  http://www.cboe.com/LearnCenter/CoveredCallOptions.asp It is suggested that you read their views and explanation of covered calls, but make sure you arrive at the Summary  near the end of the page where you will find this statement:

"This strategy is actually more conservative than just buying stock, due to the fact that you have taken in premium and lowered your breakeven price on the stock position. The covered write allows you to be paid for assuming the obligation of selling a particular stock at a specified price." This statement is not to be construed as meaning the CBOE agrees with, or recommends Systematic Covered Writing.  The point being made, and verified, is that covered call positions are a more conservative investment than individual stock positions involving the same stock positions, nothing more ... nothing less.  In fact, they are so conservative that you are allowed to enter covered call positions in an IRA account.

SYSTEMATIC COVERED WRITING
Copyright © 2005. All rights reserved.
Revised: 05/12/05