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Additional Income:

Options buyers must pay an immediate premium when entering into a covered-call option. It’snon-refundable, and paid when the contract is struck, creating an immediate cash infusion. The more volatile the stock, typically, the higher the premium.

Enhance Overall Return:

Premiums from covered-call options increase overall portfolio value.

Margins:

“Clients don’t have to post margin in their account for covered-call options, because they have already pledged their shares against the option,” Kostic says. “For conservative investors, this is a big advantage over other types of options or futures contracts which could require significant margin deposits in a volatile market.”

Drawbacks

Loss of Control:

An investor who enters into a covered-call options contract must hold the stocks for the duration. Charbonneau states covered-call options “add another element of risk to a portfolio because the shareholder’s underlying stock position can get called away at the strike price should the market trend higher.” (The covered- call seller does get compensated for this risk through income from the option premium.)

Fees:

Fees vary depending on the commission structure. Selling options involves multiples costs:

  1. a trading commission cost (depends on the number of option contracts transacted);
  2. the bid-ask spread of the option (often hidden and not easily determined); and
  3. the premium (when buying options), which is a cost to the buyer.

The premiums and bid-ask spreads tend to change alongside market conditions, and DIVUTS: (dividend yield of the underlying stock; interest or risk-free rate; volatility of the underlying stock; underlying stock price; time to expiry of the option; and strike price on the option written).

Accessibility:

Implementing covered-call strategies requires an options licence. Also, Charbonneau adds, “the Canadian options market is not as liquid or as deep as the U.S. market, so writing call options on some mid-to-large-cap companies may be difficult, and the options premium may not justify the strategy if investors are giving up too much upside in the stock for too little option premium.”

Some ETF sponsors build and manage covered-call option strategies within their products, but they are limited to large-cap and liquid stocks on the TSX.

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