Question:
What is the smallest portfolio on which one can write covered calls?
Monday Morning Millionaire Program Answer:
In line with your personal asset allocation, your portfolio should be large enough to allow you to buy at least one board lot (100 shares) of the underlying security on which you want to write covered calls on. That would allow you to sell one covered call contract.
Even though the premium income always makes you money when writing covered calls and never loses money, you risk an opportunity loss.
That is, you might be assigned and need to sell your underlying security below market value. While that could well be above your book value, it is no fun to have to sell below what you could be getting. An additional risk is that the underlying security could drop by more than what the premium income brings in. We do not recommend writing derivatives in your core portfolio unless you can tolerate a high degree of volatility and have some experience.
To repeat, investors always make money writing covered calls (or cash-secured, uncovered puts) and never lose money, they do face opportunity losses and the possibility of having the underlying security drop by more than the premium income. Over the course of a decade or more, buying and holding an index exchange-traded fund is likely to do better.
