Writing covered options & potential problems

Kemclifton

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I have been considering writing covered options (against shares owned) for a long time, since a friend had been doing it and earning good money each month. He used the option premiums to pay interest and spent the balance taking family trips overseas.

He had been doing particularly well in the rising market from 2008 and had borrowed against his home to buy 3000 RIO shares at probably $70 each.
Because the stock was raising up he had been exercised a few times, the last being at say $80 in about October 2011. He then repurchased the 3000 shares at $83 being the new market price. (Note dates and $ are approx only, it is the basis that is important).

On a previous short term decline in RIO's price he had sold out, thereby crystalising at a $27k loss, only to see the share price quickly recover up, so he had decided not to do that again and to ride out any downturns in price.

Having borrowed more money each time his options had been exercised, his loan had grown, but so had the value of the RIO shares - so no problem! But then RIO and other material resource stock prices began a long slide down to the current value of $56. So my friend is in a hard place, paying interest on a large mortgage and not writing options as he does not want to get exercised on his shares at these low values.

I feel he should be writing options and run the risk of crystallizing his loss, but at least he is earning income to pay his interest, but am I correct?

I am still thinking of writing options on shares I own, but should I only write them when I think the market is likely to go down or sideways? I would value informed advice on these two questions!
 
Natenberg is a good place to start. "Option Volatility & Pricing". Steer clear of your firend.
 
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