Image source: http://www.optionsizzle.com/wp-content/uploads/Best-Way-To-Use-Covered-Call.png
Have you heard about Writing Covered Calls on CFD's?
The strategy involves selling call options on existing shares that you own. If the price of the share moves above the price that you wrote the call option at, and the owner of the option decides to exercise their right to buy your shares at the price you wrote it at, then you are obliged to sell your shares to them. However, if the price doesn't move above the price you wrote it at for the month, or the owner of the option doesn't decide to exercise their right to buy your shares, then you keep the premium they paid you for the option, still own your shares, and can continue to execute the same strategy each month for the entire time you own the shares.
As you continue to write covered calls on your same parcel of shares, your break even on the share price keeps falling, potentially making your investment in the shares not only more profitable, but also less risky. Eventually, it may be possible to fully recoup your initial investment in the shares through the accumulation of option premium income. In other words, over time you may be able to "pay off" your shares so that you still have the shares, but they no longer owe you anything.
Using the Writing Covered Calls with CFDs strategy, the writer of the call options buys the CFDs rather than the shares, but otherwise the strategy works in much the same way as Covered Calls.
It is also essential your broker can offer you the backend services in order trade this strategy (writing covered calls on CFDs). At the time of writing this article (July 2011), there is only one broker in the world (that we know of) who offers clients the ability to trade this strategy. Investors looking to buy a parcel of CFDs and then write call options on the underlying CFDs need to think about the implication of cross marginalisation. There is significant risk for the potential investor who trades this strategy (writing covered calls with CFDs) with a broker who's backend systems do not recognise the combined CFD and Options as one strategy.
There is one difference between writing covered calls on shares and writing covered calls on CFDs other than the increased leverage comparatively. That is; CFDs are completely prohibited in the Unites States as part of the Securities and Exchange Commission restrictions on Over-the-counter instruments.
Combining the United States' dominant and profitable Options Market with the highly competitive CFD market (which are commonly traded in European and Asian markets) could cause quite an interesting debate in the financial markets world. On one hand, you have a leveraged product such as CFDs which post GFC has attracted scrutiny as a risky instrument; and on the other hand you have an instrument (Options) which were designed to reduce risk.
The combination could arguably be favourable for United States Options Exchanges as it is the Options Exchanges primary role to increase liquidity into the market and this strategy (writing covered calls on CFDs) may well provide them with that.
Could this strategy potentially persuade the introduction of CFDs into the United States financial market?
Only time will tell.
