Can someone quickly explain the basic option overlay strategy?

Ok, so would it be fair to say that the general goal of a basic option overlay strategy is to potentially take a long (or short) position in the market and write calls and sell puts as a means to reduce the overall risk exposure of the position?
 
Here's one I did last week- bought 100 COP at $49.40. Sold the Jan 2010 call with a strike price of 50 for $978. If COP finishes above $50 in Jan 2010, I get paid $5978 for the stock I paid $4940 for. If it doesn't I keep the stock and the $978.
 
Quote from ScapGF:

Ok, so would it be fair to say that the general goal of a basic option overlay strategy is to potentially take a long (or short) position in the market and write calls and sell puts as a means to reduce the overall risk exposure of the position?
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1) Writing a (covered - that means you own the shares) call does provide some protection, but it's limited to the premium you collect when seling the option.

So yes, it does reduce exposure.

But if you are looking for significant reduction in exposure, this is not the strategy of choice.

2) Selling puts does NOT reduce your exposure. It increases it significantly. In fact, it essentially 'doubles up' your position.

If the market rallies and the puts go away (expire), you will enjoy the extra profit that comes from the premium you collect when selling the puts.

But, if the market declines, and your puts move into the money - unless you repurchase those puts (presumably at a loss), you eventually will be assigned an exercise notice and forced to buy more stock.

If buying that extra stock is what you WANT to do, then your overall plan is okay.

But, if you are looking to reduce risk, this is not the way to go.

3) I don't want to overload you right now, but there are alternative strategies you can consider - and all of them have much less risk than writing covered calls and/or selling puts.

See this post for six recommended strategies:

http://blog.mdwoptions.com/options_for_rookies/2008/06/recommended-opt.html

You can find additional posts that provide much more information on any of those strategies.

Mark
 
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