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Options: Covered Calls v. Naked Puts

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  1.  Report Post# 1
    I've now seen two different posts in comments to two of the Gumshoe's write-ups by two different posters in the last month to the effect that "selling a covered call has the exact same risk profile as selling a naked put".

    I'm not certain where the posters are coming from, unless they are looking at one of those silly option risk profile graphs that is long on theory and short on practical application. Selling a covered call does NOT carry exactly the same risk as selling a naked put. If you sell a covered call and the option gets exercised, your stock gets called away. You no longer own it. You get to keep the premium you were paid for the call and the difference (gain) between the price you paid for the stock and the strike price (the price at which the option was called away). In short, you make money on the trade if the option gets exercised. (You also make money if the option expires worthless and you keep the stock, as long as the price of the stock doesn’t go down more than your purchase price plus the premium you were paid for the call).

    On the other hand, if you sell a naked put and it is exercised, the stock is “put” to you at the strike price. In other words, you become the proud owner of the stock instead of having it called away, the complete opposite of what happens in the covered call scenario. When the put is exercised, you will have a paper loss.

    As for theoretical risk, there’s no more risk in either strategy than that the stock price could go to zero. However, in the covered call scenario, that is NOT a risk of holding the short call. It’s a risk of owning the stock. Therefore, neither strategy is any more risky than owning stock.

    Finally, the "proof" that covered calls are less risky than naked puts is that the put sale carries with it a margin requirement, the covered call sale does not, for the obvious reason that you already own the collateral.
    • CommentAuthorqueenjo
    • CommentTimeJun 1st 2009
     Report Post# 2
    I know this is an old thread but it caught my eye because I was doing a lot of covered calls.
    I say WAS because the rule of thumb is that the options volatility index must be > 30 or the value of the options for a covered call strategy are not worth it.

    Ie. keep your eye on ^VIX and the higher it goes, the higher the prices for the premiums you get on writing covered calls goes up. Take a look at the graph of ^VIX during this past year. During the bad time of October 2008 through the bottom of the Market in March, the volatility index was the highest in 5 years.
    If you understand how to do Covered calls and pick the right stock, this is a great way to make some serious dough in a down market.

    Now in June 2009 , I can not make anything on covered calls.

    Something to keep your eye on when this false market spike we are in ends in the next few months.
    • CommentAuthorasafp
    • CommentTimeJun 1st 2009
     Report Post# 3
    I've been very skeptical of this bull market and/or bear market rally. It is beginning to look like a "buying panic" like I've never seen in my lifetime might be necessary before we go back to normal. I do think that normal will resume at some point.

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