uh oh......
Is This Options Strategy Realistic?
- Thread starter ess1096
- Start date
1) selling a call earns premium on time decay.
2) buying a put, you fight time decay. so option value may decline even if underlying moves in your direction.
3) a decrease in implied volatility after selling options is great for the seller, as they buy back their obligations for a cheaper price, assuming underlying is priced the same.
4) a decrease in implied volatility after buying puts lowers the value of the put, if the underlying is priced the same.
generally, sell options and spreads when price movements anticipated are small, buy options when anticipated price movements are large. And use spreads to reduce your cost of long options, but acknowledge you'll lose some capacity to gain as much. So risk/return ratio goes down.
You get what you pay for in life.
Don, you will need to have one heck of a good swing trade to profit with calls. The primary swing system I trade is as good as any I've seen, and it is still difficult to overcome the spreads and decay to make options work for me. The best way to demonstrate this for yourself is simply to spend a few weeks tracking your positions as though you had them as calls instead of the underlying, and you will see the problems.
Since nobody has said it yet, I will.
You really need to read, and understand completely, a basic options primer. I think you misunderstand the nature of options as being simpler than they really are, ignoring the concepts of time value and volatility, not to mention things like pin/early-exercise risk, the limitless loss potential of naked calls, etc. You will get yourself into trouble without knowing this basic stuff perfectly.
You really need to read, and understand completely, a basic options primer. I think you misunderstand the nature of options as being simpler than they really are, ignoring the concepts of time value and volatility, not to mention things like pin/early-exercise risk, the limitless loss potential of naked calls, etc. You will get yourself into trouble without knowing this basic stuff perfectly.
Thanks for the concern. I have no intentions of diving straight into the abyss. Paper trading only with Options for now. Got my nose buried in McMillian on Options and when I am ready to test the waters it will be nothing fancy at all. I'll probably practice my swing trade strategy using 1 contract in place of a stock position just to get a "feel" for it. Naked puts, straddles etc. wont even be in my vocabulary for a long while.
Just to blow your mind... A covered call is exactly the same as a naked put.
It should be more precisely said: Selling a covered call and owning the underlying provides the same risk as selling a naked put.
If a stock goes up past strike point after I've sold a covered call, I've lost out on gains. If a stock goes down past strike after I sold a naked put, at settle I lose x dollars past strike x100 per contract.
Now for how they are equal: Stock ownership provides the downside risk of selling a put. Selling a covered call provides the premium comparable to the one earned selling a put. So as a composite, I can see how they are similar. But long term stock ownership provides dividends and different tax status possibly.
I could also venture to stay selling naked puts is no riskier than owning the underlying stock, as well. And selling covered calls may psychologically amplify the risk of holding the underlying, since to exit the position, (depending on the type of brokerage account you have) you often need to cancel out the open negative call position before you sell.
Of course, what gets people into the trouble is not the fact they're selling naked puts, but how many of them they're selling since premium they command isn't usually much.
Whether you're doing synthetics (sell call atm, buy put atm or inverse), owning underlying - you're exposed to practically enormous losses. Vanilla stock ownership doesn't have hedging built in, so these tools are all useful.
Its really amazing how much risk stock ownership entails, even in high quality companies. One correction of an economic event, even in quality companies (ie XOM, etc) can wipe out 20%. And one crash can wipe out 50%. Its amazing how much risk the general stock and unhedged mutual fund buying public tolerates. It seems its built into most of the American spirit to be bullish on everything, a la Cramer... To me, it seems naive. Options give an excellent way to protect from drawdown, as well as give fantastic growth opportunity. The secret is in not getting too greedy and overleveraging the smaller bets and taking too much risk, a la selling too many spreads for too little return and buying too many contracts for too small a portfolio.
I'm not a fan of buying deep ITM calls or puts - it just doesn't seem to make sense compared to owning the underlying or a synthetic. Too much chance for premium to disappear.
I agree with many of your other points. However, a *covered* call has the same risk profile as a naked put.
A rally makes you a fixed profit. A decline has "unlimited" risk. Sure, you've hedged a tiny bit with the option premium of the sold call, but it's the same as the premium of the sold put. Run it through a risk analyzer some time--a stock at 40 has the exact same risk/reward profile selling a naked 45 put as it does buying the stock and selling a 45 call.
Covered calls are often pitched as a "risk free" way of making money on your stock. In essence, you could employ a naked put strategy and make the exact same amount of money.
The exception is if you're holding stock for long term capital gain purposes, then selling calls against it may be a reasonable way of making money (if you were planning on keeping the stock anyway). A friend of mine sells calls against his stock, and if the calls go in the money, he buys them back so he doesn't pay cap gains taxes on his stock.
You're right - i edited my post to reflect a complete think through right before you replied.
and with put bull spreads, you can do even more.
and with put bull spreads, you can do even more.