Protecting Your Stock Trade by Diversification - dummies

Protecting Your Stock Trade by Diversification

A diversification strategy is pretty simple, and it works best when you own more than a couple hundred shares of a stock. In this strategy, you sell more than one covered call at different strike prices and for different time frames.

The goal is to spread out your risk against volatility and your risk against the call you sold being exercised. You accomplish this strategy by writing in-the-money calls on some stocks and out-of-the-money calls on other stocks in your portfolio.

Setting up this strategy is difficult because writing out-of-the-money calls theoretically works better when you write them against stocks that do well. In other words, you’re forced to decide which stocks you think are likely to do better than others, which is difficult to do in a simple stock-picking strategy without the option strategy.

Conversely, writing in-the-money calls works better for stocks with low volatility. One way to get around this problem is to write half of the position against in-the-money and half against out-of-the-money on the same stock.