Quote from c.chugani:
I always hear this tremendous risk with naked puts and covered call strategies but lets assume one is investing long term:
wouldn't covered calls reduce the average cost per share? Isn't it a method to generate income from stocks you are willing to hold in your portfolio?
Regarding naked puts, the same thing applies. For example, if one wants to operate long term, and wants to buy a stock at 3 dollars. But said stock is currently trading at 5 dollars. Well you sell puts at 3 dollar strike and if they end ITM - well you were willing to buy the stock at that price anyways, right? On the other hand if they end OTM, you end up with a premium..
What other associated risks do these two strategies have?
1) Your statements are valid, if you have ENOUGH cash to cover a naked put trade, and your intention is to BUY the underlying anyway. Then it is a good strategy. I used it many times with good results.
a) I want to buy 1000 shares of xyz at $20
b) I sell xyz 20P at $1 premium
c) If xyz never drops to $20 at expiration, i pocket $1 and walk away.
d) if xyz drops to $20, i let it get assigned. My cost basis is now $19.
e) I then sell a covered call - 21C at $1. If xyz goes above $21 at expiration, i walk away with $2 +$1 . Else my cost basis is now $18 vs buying the stock outright at $20.
Of course above is only an EXECUTION method. You still need some edge / TA to pick the correct underlying entry and strikes to begin with. Just like if you are buying the stocks outright.
2) People get in trouble when they start to naked short highly vol stocks such as leh, solf, etc.. and take on large positions that barely meet the margin requirement. Then when the stock gaps the other direction even briefly, you are in a world of hurt.
I found writing naked call/put on the spx/es pretty good, because it's relatively stable and you can somewhat predict the movement to be at most ~5% in either direction. As oppose to above mentioned stocks, where it can gap 10-50% in a day or 2.
