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We invest to earn an income to live on. To that end, it is just as important to protect the capital by minimising loss as making big profits.

If you read my previous posts you should have learned that I have 5 opened positions using a mixture of calendar put spreads, put spreads and covered call methods. All the methods are chosen aiming to eventually ending in covered call trades with a suitable long put option for insurance. For my risk preference, I like to have the insurance for protection against unexpected adverse events such as the Enron or the Lehman Bank catastrophe. It is ideally to have the longest possible period of insurance but it will be determined by cost.

All of the positions except RCII are going as planned. When RCII shares were around the $20 level, I entered a RCII calendar put spreads of 5 long June 2010 $20 put and 5 short November $20 put. Guess what happened next? Exactly! RCII dropped $2, now hovering around the $18. Last time I peeked, it was at $17.91.
Ma Ma Mia!

It is very good example for showing the superiority of the covered call method against buying the shares out right when risk is the only consideration. I know this is a calendar put spread but I regard it as part of the covered call arsenals, one for all and all for one marching toward a good income!

How do I justify saying covered call method is safer than buying the shares outright?
I will show you:
· Buying the shares at $20 and if the price remains at the $18 level, that is, the only way out is sell out and lose about $1000 for 500 shares. If it remains at the $18 level, you can sell the $18 call for the premium of course. Covered Call again! HaHa!
· If the price should drop further, heaven forbids, I am sure the nerve would be jangling and sleepless nights and eventually forced to sell out at whatever loss!
· What about the calendar put spread on route to covered call? I have prepared to accept the maximum loss right from the start. I also have the money management in place so even the maximum loss should not affect my overall financial excessively. Regardless how the share price should behave, I shall sleep easy.
· Further more, unlike buying the shares outright, it could be possible to reduce the loss and I shall discuss below.

In my RCII position, regardless how much lower the share price goes, the loss will be limited to $1.52 per share, the cost of the long put plus trading costs less the premium from the short put. There are ways to minimise the level further.
· It is possible to close the position immediately and accept a small loss of about $0.30 per share.
· Let the short put exercised and then sell both the shares and closed the long put. Financially, the result will be similar to closing the position outright, however with greater flexibility in the timing of selling the shares. The risk will be much greater though with the shares unhedged.
· Simply roll over to the next month for a small premium every month. This can be done for several months, gradually reducing the overall cost from the current $1.52 per share. It requires the share price remains at the current level of around $18 though.
· I am seriously considering rolling over the short December $20 put to the January 2010 $17.5 put. Although it will add over $1.2 to the overall cost, making it over $2.80 per share. It will mean exercised to buy at $17.5 and sell at $20. I believe the manoeuvre would improve the chance of the trade to eventually end in profit judging by the behaviour of RCII price lately.
· If confidence of RCII share price to stay below $20 is very high, it is also possible to open another front with the call spread. Sell the December $20 call and buy the December $22.5 call. Right now the short call option premium is too low for taking this action.

In conclusion, there is very good chance for my RCII trade to come good eventually even though the share price has not been cooperating. With sound judgement, adjustments to the position may be made to help. However one must accept that the share price may behave most unexpectedly. Any adjustments might also do harm than good.

Whatever happens, the maximum loss may be predetermined to an acceptable level according to one’s risk tolerant requirement.