We are always concerned when a reader is trading with money that he or she cannot afford to lose. This can lead to poor trading decisions and consequent losses, as embodied in the old Wall Street adage that "scared money" never wins. The reason is of course that a person trading scared money frequently will make bad decisions due to panic or paralysis. Anyone trading money that cannot be lost must realistically face the prospect that the money, or at least a good chunk of it, could be lost in trading.

Yet many people have no other money available for trading and feel a strong need or desire to try, despite the risks, to grow the money in order to better their financial condition. And it can be done, but only if the trading is approached realistically, with a focused commitment to manage the money effectively. The question of whether to trade scared money actually resolves into two questions:

1. Should the money be traded at all?

2. If it is to be traded, how can it be traded most effectively and safely?

It is not our place to tell people to refrain from trading money they can't afford to lose, but to point out the risks and to help them trade effectively if they choose to trade. The purpose of this article is not to teach the strategy discussed below - space simply does not permit that - but to point out a relatively safe and productive method for trading money that the trader dare not lose.

The Covered Call Strategy for Income and Safety

Regarding the second question above, based on our experience we have learned that covered calls can be traded for consistent profitability and with relative safety. In fact, covered calls are the one option-related trading strategy that most brokerages will allow to be done in I.R.A. accounts. The reason is that covered calls provide a combination of income (like receiving a monthly dividend check) and downside protection should the stock drop. Merely owning a stock produces no income and no downside protection.

If you are not familiar with covered calls, they are simple: you buy shares of stock and sell call options ("calls") on them, and the price you get for selling the calls (the "premium") goes into your pocket as income. If the calls you sold are exercised, you are obligated to sell the stock at the calls' exercise price, which is known as being "called out" of the stock. Because you own the stock underlying the calls, the calls are "covered" and you have them available for delivery to the buyer if the calls are exercised - - if you didn't own the stock, the calls would be naked. If you are not called out of the stock when the calls expire, you either sell the stock or sell more call options on the stock the next month for more premium income.

Every month you do the same thing: buy stock, sell calls, pocket premium income. It's like collecting a monthly dividend from your stocks. This strategy can generate a steady monthly income that averages 3% to 5% a month.

Example: On February 7th Goodyear Tire & Rubber (GT) shares could be bought for $10 and the February $10 calls could have been sold for a $0.50 premium. In this case, the return is calculated by simply dividing the stock price into the premium received. This trade creates an instant return of 5% for a 14-day holding period, since the FEB calls expire on February 20th. Upon writing the calls, the $0.50 premium goes into your account. A call option contract covers 100 shares, so three contracts would cost $3,000 to buy the stock (300 x $10) and yield $150 in premium (300 x $150). The premium received protects you against a drop in the stock price down to $9.50.

The $150 return in our example may not sound like much, but it is a 5% return on a $10 stock. And if the stock is not called out (sold), the calls can be written again, month after month. Or the GT shares could be sold in order to buy another stock and write covered calls on it.

Six Safety Rules You Need to Know

To successfully trade covered calls, it is necessary to observe certain safety rules. CallWriter has over the years developed a simple but comprehensive set of rules for making consistent profits writing covered calls, which we teach to CallWriter members. It's so unique to us that we have named it the CallWriter Method. The key is to focus not on trying to get the highest returns but on getting the highest combination of return and stability in order to eliminate those pesky losing trades that wipe out many successful trades. In other words, it is not enough to make good returns; successful money management requires that you also control losses. And the best way to avoid losses is to avoid situations that historically are likely to cause losses.

Clearly, writing covered calls is one of the more conservative strategies available, and can be used very effectively even by people with relatively small trading accounts. But every trading strategy can lose if executed poorly, even the covered call. If you are going to trade covered calls with money you'd best not lose, you should consider the very conservative approach embodied in these simple trading rules:

1. Stick with household names. Concentrate in the larger, more stable stocks such as the S&P 100 and the larger Nasdaq 100 stocks in your price range, which offer the best combination of return and safety.

2. Avoid money losers. Stick with companies that have positive earnings. There are many exceptions to this rule, but for safety it is better to avoid the money losers.

3. Avoid pharmaceutical and biotechnology stocks. These are companies whose drugs or devices are regulated by the F.D.A. When one of these companies has a critical product fail to get F.D.A. approval, the stock can tank. They generally are too dangerous as covered call trades for anyone but experienced traders.

4. Avoid life or death news. If an important news event is expected to occur before the calls expire (resolution of major lawsuit, major contracts are being bid on, etc.), avoid the stock. The reason is that the stock will almost certainly drop if the news is adverse, and it may drop even if the news is good if it has already run up on the expectation of good news. This news is not usually hard to uncover and you can usually find it at free sites Yahoo! or CBS Marketwatch.

5. Stick with rising stocks. The stock ideally will be in an uptrend, meaning that it is making higher highs and higher lows.

6. Stay in the money. A call is in the money if its exercise price is lower than the stock's price. The deeply in-the-money (“DITM”) calls usually offer lower returns but provide the most protection if the stock drops.

Example: A stock is trading at $17.80 and the $17.50 call can be sold for $1.75, which would produce an 8.15% return. The fat premium protects you down to $16.05 (17.80 - 1.75). However, you are concerned that the stock is at a high and could pull back. In that case, it might be smarter to instead sell the $15 call for $3.80, which would produce only a 5.62% return but provide protection against a price drop all the way down to $14 (17.80 - 3.80). The more conservative trader would sell the deep-in-the-money $15 call, because it offers an acceptable return but confers far more protection. If the stock should drop before expiration to $15, the writer of the $17.50 covered call position is hurting, but the writer of the $15 call position is smiling.

These rules have come out of observations made by us at CallWriter in years of covered call trading and will serve the careful trader well. There is of course more to consider in covered call trading than the few points made above. But you might be astonished how well these six simple rules work for covered calls, month in and month out.

But successful covered call writing is not difficult; it simply requires patience and a bit of knowledge. That's why CallWriter is so successful in covered calls and is the world's premier covered call website. We have the proprietary tools to find the highest-returning covered call trades, an amazing trade calculator that manages trades and squeezes the most profit out of them, and we provide a time-tested analytical method for profitable covered call trading.

Ways to Try CallWriter Try CallWriter for 10 days without risk - absolutely free! You'll have full access to our membership site! A $27.00 value Details Buy one month of CallWriter membership and get the second month free! $79.95 Save $79.95 Details Buy John's Ultimate Covered Call Book now and get two full months of CallWriter membership. $139.95 Save $119.90 Details Contribute an Article To contribute an article to the Money NewsLetter, send your contribution, along with your promotional byline, to: newsletter@callwriter.com. We don't pay contributors, but we will include your byline and a link to your website. Reproduction Don't hesitate to print out this newsletter for your own use or forward a copy of it to your friends and associates (we want you to), but please ask permission before reproducing the content in any form -- we would like to know who you are and how you are using it. Disclaimer We are not brokers, investment advisers or securities analysts and do not recommend the purchase, sale or holding of any security. Your use of any information or strategy appearing in this newsletter or on CallWriter.com is solely at your own risk. We urge our newsletter subscribers and CallWriter.com website members to do all requisite and analysis and properly plan each trade prior to making the trade and to manage each trade effectively. Covered call and other potential trades discussed in this newsletter or on CallWriter.com do not constitute trading recommendations by CallWriter or any other person and are presented by solely for informational and educational purposes.