Chapter 2: Covered Call Writing 47 
basis. If the write were done in a margin account, the return would be considerably 
higher. 
Note that we have ignored dividends paid by the underlying stock and commis­
sion charges, factors that are discussed in detail in the next section. Also, one should 
be aware that if he is looking at an annualized return from a covered write, there is 
no guarantee that such a return could actually be obtained. All that is certain is that 
the writer could make 8% in 9 months. There is no guarantee that 9 months from 
now, when the call expires, there will be an equivalent position to establish that will 
extend the same return for the remainder of the annualization period. Annual returns 
should be used only for comparative purposes between covered writes. 
The writer has a position that has an annualized return (for comparative pur­
poses) of over 10% and 8 points of downside protection. Thus, the total position is an 
investment that will not lose money unless XYZ common stock falls by more than 8 
points, or about 18%; and is an investment that could return the equivalent of 10% 
annually should XYZ common stock rise, remain the same, or fall by 5 points (to 40). 
This is a conservative position. Even if XYZ itself is not a conservative stock, the 
action of writing this option has made the total position a conservative one. The only 
factor that might detract from the conservative nature of the total position would be 
if XYZ were so volatile that it could easily fall more than 8 points in 9 months. 
In a strategic sense, the total position described above is better and more con­
servative than one in which a writer buys a conservative stock -yielding perhaps 6 or 
7% - and writes an out-of-the-money call for a minimal premium. If this conserva­
tive stock were to fall in price, the writer would be in danger of being in a loss situa­
tion, because here the option is not providing anything more than the most minimal 
downside protection. As was described earlier, a high-yielding, low-volatility stock 
will not have much time premium in its in-the-money options, so that one cannot 
effectively establish an in-the-money write on such a "conservative" stock. 
COMPUTING RETURN ON INVESTMENT 
Now that the reader has some general feeling for covered call writing, it is time to 
discuss the specifics of computing return on investment. One should always know 
exactly what his potential returns are, including all costs, when he establishes a cov­
ered writing position. Once the procedure for computing returns is clear, one can 
more logically decide which covered writes are the most attractive. 
There are three basic elements of a covered write that should be computed 
before entering into the position. The first is the return if exercised. This is the return 
on investment that one would achieve if the stock were called away. For an out-of-the-