Reducing your losses! – Subramoney

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There have been many bankruptcies of brokerage firms and people have lost a lot of money. The biggest scam of the year of 2019/20 must have been Karvy at Rs. 5000 crores – but others like Anugrah at Rs. 1000 crores were not small either.

I am not getting into how people lost money, but one way of dramatically reducing losses is by writing “Covered Calls”. Practically speaking, if you write calls every month, you will surely make more money than the dividends you receive, and chances are you will not lose money. Anyway you own the underlying share, so in a worst case scenario you can sell the share – the amount you lose is only the premium. Exactly how it works in insurance – you never regret the medical / car /term insurance premium paid, do you.

WHAT IS WRITING A COVERED CALL?

Regardless of your short-term view on the market, over the long term, covered call strategies may enhance risk-adjusted returns. You may also be able to use this to capture some of the upside and downside ratios.

Smart and Active investors seeking to improve their equity returns and reduce the risk (improving the risk-adjusted returns) should learn the basics of Futures and Options and get their broker to help them write covered-calls. This is a good way to reduce the downside risk exposure while meeting the cashflow requirements without selling a part of the capital – and unnecessarily paying capital gains tax.

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I do believe that by using an equity covered call strategy, investors can reduce portfolio volatility by capturing option premiums, without giving up the benefits of long term holding. I realize that over the past 20 years I could have earned well from my portfolio of Colgate, Nestle, Cummins, Siemens, Hul, – while holding them passively. If I were to hold them anyway for such long periods, why not write options? In a covered call strategy, investors sell call options against their equity holdings and receive an upfront “option premium” in exchange for forgoing potential capital appreciation if the underlying stock price increases over the strike price. These option premiums generate cash flow which help to mitigate some of the downside risks to owning the stock. Look at it like taking a term insurance policy that you take – you own your life and so you are willing to pay a premium to ensure that your family is compensated if you die. Look at car insurance, etc. Cov-call writing is a place where you are acting as an owner and passing on the ownership ABOVE A PARTICULAR PRICE (called the strike price) to a buyer of the option. If the price does not go up, you keep the premium. In 9 out of 12 months you will get to keep the premium, if you are sharp, and are willing to be agile. Sadly 99% of investors and 100% of mutual funds are too lazy to do this. I have seen a few enabling resolutions, but not sure about how many of them do it.

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I prefer single stock options – there are fewer players who write single share options, but the Index options is a very crowded market. Crowded markets means you are safer, and the premiums lesser. Also since most of us do not have large Index investments it does not become a perfect hedge for our holdings. If I were to write options in Cholamandalam Finance, Sundaram, and Bajaj Finance – among the finance companies that I own and or banks like Hdfc, Yes and Bandhan – I could do better simply because this market is less crowded, and therefore more volatile.

I wonder if a big fund house can create a CLOSE ENDED COVERED CALL WRITING fund – and use the underlying assets of all the other schemes as a portfolio and write options? Sounds wrong, but just taking a chance!

Personally, I am too lazy to write covered calls. I would prefer playing scrabble online during that “thinking” time.

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Subramoney

Subramoney

As a professional trainer, Subra trains a lot of people – corporate employees, promoters, non-finance managers, fund managers, entrepreneurs, life insurance agents, journalists, PR agencies, and anyone who wants to learn. His style is simple – He tells stories of real people, real experiences, and breaks down complicated topics into easy to understand lessons.
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