Using Margin With Covered-Calls
If you are one of our regular readers, you know that our favorite covered-call plays are generally very conservative and almost always "deep-in-the-money." We focus on this method because our primary goal is to provide positions that generate consistent, acceptable returns while still receiving an above-average amount of downside protection. Buying stock on margin in a covered-call position is an excellent way to enhance profit potential when the technique is used correctly. The advantage of trading on margin is that your gain is a successful position is doubled. The downfall lies in the fact that you may be asked to contribute more collateral to the brokerage account should the value of your stock decline significantly. With our in-the-money approach to writing covered-calls, we do not expect you to own the stock at the end of the strike period and that is the primary reason a margin loan is viable for many investors. If you open a new position and the outlook for the underlying issue turns negative (falls below technical support or a recent trend-line/moving average), we recommend you consider closing or adjusting the play to preserve capital. As with any investing strategy, the key to success is to monitor your positions closely and use sound judgment (no emotions!) when making decisions. If you follow this practice, the draw-downs from losing positions will always be kept to a minimum and your remaining funds can be moved into other, more profitable plays.
Brokers and Commissions
These websites will help you review the different features and limitations of each online brokerage:
Then visit the chat sites and message boards such as:
for other trader's experiences. With regard to overall popularity, Ameritrade, Brown & Co., E-trade, Interactive Brokers, Mr. Stock, E-Schwab, OptionsXpress, and ScoTTrade seem to be the most commonly used brokerages among the readers of this newsletter.
As far as commissions, we do not include the cost of trading in the return on investment calculations because different brokerages charge varying commission fees and with discount online brokers, the overall effect on most positions is minor. For example, one popular broker charges $17.50 to trade 10 option contracts. On a 1000 share/10-contract position, this represents a cost of only 3.5 cents per share. Obviously, that's a relatively small amount for most option-trading strategies, but commission costs are certainly a crucial part of the risk/reward calculation with in-the-money covered-calls, thus it is important to understand how they affect the potential gain of each position.