Risk difference on covered call v. naked put

[maw]

I am by no measure a sophisticated options investor. I am an engineer though, so I know that those greek letters refer to some kind of variables which mean something to somebody.

Anyway, I own 1100 shares of MDT (Medtronic). I few years ago I discovered covered calls. Since then I've been selling calls when the conditions are right: I want $1/share, the strike price to be at least $2 higher than the current price, and no more than 3 months out. I get this opportunity a couple times a year, after a good up-trend of course. I've never been exercised.

Recently I got to thinking. Why not put $50k in this account and try selling naked puts (10 contracts worth). Out of the money, at least $2 below current price, no more than 3 months out. As nazzdack pointed out this would set up nicely after a couple of huge down days.

Now you don't have to be a genius to figure out that there would be more risk accociated with the puts. However, 1)Medtronic is a solid company with a long history so whats the chance of a disaster, and 2)I could hedge by setting a stop(sell) somewhere below the put strike if I do get exercised.

I figured the OP received plenty of technical replies, maybe something more pedestrian would be appropriate.

 

[maw]

That's a good point. And I would lose money under that scenario. But it is defined, isn't it?

If I sell $45 puts for $1 and the price falls and I get exercised. Then, I set a stop loss (sell) at $43, and this trade gets executed. Haven't I only lost $1/share? $2 on the trade (45-43), but I made $1 on the put sale, net $1 loss.

 

[riskfreetrading]

Quote from maw:

I am by no measure a sophisticated options investor. I am an engineer though, so I know that those greek letters refer to some kind of variables which mean something to somebody.

Anyway, I own 1100 shares of MDT (Medtronic). I few years ago I discovered covered calls. Since then I've been selling calls when the conditions are right: I want $1/share, the strike price to be at least $2 higher than the current price, and no more than 3 months out. I get this opportunity a couple times a year, after a good up-trend of course. I've never been exercised.

Recently I got to thinking. Why not put $50k in this account and try selling naked puts (10 contracts worth). Out of the money, at least $2 below current price, no more than 3 months out. As nazzdack pointed out this would set up nicely after a couple of huge down days.

Now you don't have to be a genius to figure out that there would be more risk accociated with the puts. However, 1)Medtronic is a solid company with a long history so whats the chance of a disaster, and 2)I could hedge by setting a stop(sell) somewhere below the put strike if I do get exercised.

I figured the OP received plenty of technical replies, maybe something more pedestrian would be appropriate.

Friend:

That is a wrong strong for buy and hold: it has been range bound for 4 years! Strong company indeed, but price going no where. I am positive that the main money you made was from the calls you sold.

Your analysis of when to sell call is good, but the call you sold was not the best you could have done. I would have gone ITM when at upper range, and continue writing calls when in middle of range using your logic.

I think you would have made more money. If assigned on certain stock, I would have sold puts on the lower range price, to require stock you would have been assigned on if any.

Learn more about how to be a much better spreader.

Here another way to look at what you did. suppose you sold the call at upper range. You netted $2, and the stock went down to lower range (about 10 dollars). So you receive $2 for a "loss" of $8 to $10. When compared to buy and hold, you feel good, but when looked at as I just described, it is possible that you would think twice about it.

So if I were you I would have done the opposite. I would have sold all portfolio at upper range, bought the call if I thought the stock was going to break. If it does call will make money. If it does not, I lose $2k, but my money will buy same stock at lower side of range, and keep some money (10k to 8k -2K= 8K to 6K).

 

[maw]

longterminator: I won't enter the $43 stop-loss-sell unless my shares get assigned. However, I sense I might be missing something here.

riskfree...: I am trying to learn. And you're right that the only profitable thing about this stock (over the past few years) is the call selling I've done.

Maybe I should mention that this stock has some history. When I graduated from high school my father gave me 100 shares of some company I don't even remember the name of. This company got acquired by another and then another and finally I ended up with over 1000 shares of Medtronic (I'm 48 now). Also, this stock is a pretty small part of my total savings.

I do have a full time job and a limited amount of time to spend on trading. However, I am having some fun and would like to learn more. I've reread your post a few times and I think I get it. When you wrote "to require stock..." did you mean "...reacquire..."?

 

[commiebat]

Quote from longterminator:

If you are sure you want to own the stock at a lower price, then sure, go ahead and do it.

Heh. Everyone is sure they want to own the stock at a lower price, as long as the stock is at a higher price. What idiot wouldn't want to own a $43 stock for $35?

The problem with naked puts is that you only end up owning the stock for $35 when it's worth say $33, and by then you're not so sure you want it anymore.

 

[riskfreetrading]

Quote from maw:

longterminator: I won't enter the $43 stop-loss-sell unless my shares get assigned. However, I sense I might be missing something here.

riskfree...: I am trying to learn. And you're right that the only profitable thing about this stock (over the past few years) is the call selling I've done.

Maybe I should mention that this stock has some history. When I graduated from high school my father gave me 100 shares of some company I don't even remember the name of. This company got acquired by another and then another and finally I ended up with over 1000 shares of Medtronic (I'm 48 now). Also, this stock is a pretty small part of my total savings.

I do have a full time job and a limited amount of time to spend on trading. However, I am having some fun and would like to learn more. I've reread your post a few times and I think I get it. When you wrote "to require stock..." did you mean "...reacquire..."?

Sorry about the typos. I did not re-read it carefully. There are other typos, I am sure. It is reacquire.

The story of your stock ownership is interesting, and I understand the sentimental aspect. I am glad to hear that you have other savings.

Maybe what you can do is to sell calls, and use the proceeds as a cover to aquire stock via put writing. You will end up aquiring either the stock (you may not wish to aquire it this way as otherwise the value of stock would have to be lower), or money which you can use to spend or to aquire more stock (compounding) and therefore adding to what was given to you.

PS: there are two ways to own a lot of wood. One way is to own one tree and make sure it is will be the tallest (tall enough) tree over time.The second is to spend time acquiring smaller trees but large in number (own a large forest of short trees). Either way one would be able to have a lot of wood. Option writing allows you to acquire your wood via the large forest with short trees. I hope the analogy is useful. Feel free to PM me. I have an engineering background myself.

 

[riskfreetrading]

Quote from commiebat:


The problem with naked puts is that you only end up owning the stock for $35 when it's worth say $33, and by then you're not so sure you want it anymore. [/B]

good point. That is one problem. The second problem is, unlike insurance companies, a good stock you write a put on runs away, and you can not write a put on at the same strike for the same premium. So one either gives up on that stock, or accept a lower return.

It is like an insurnace company that keeps finding customers, but at the end of the year it owns "bad cutomers", and the good customers leave or require a smaller premium. It is a tough business compared to the car/whatever traditional insurance business.

 

[spindr0]

As for a stop loss sale, what happens when you sell shares as a hedge, and then the stock goes back above the price? There's no way to define your risk with a short option, call or put

If the OP is is assigned and he buys the stock, he would set a stop loss. If the stop loss is hit, his shares would be sold. End of position, end of risk.

A possible problem with a stop loss at $43 on stock bot for $44 is that there's no guarantee that you get a fill at $43. If the stock gaps, it may never trade there and the fill could be lower. It's not a regular event but it does happen.

 

[riskfreetrading]

Quote from spindr0:

If the stock gaps, it may never trade there and the fill could be lower. It's not a regular event but it does happen.

BSC stock shows it can happen (30 to 4 overnight!). That is why I do not think much of a stop on a single stock, because of gaps/black swan thing.

 

[atticus]

Quote from longterminator:

True, Rho is a consideration. If you are short puts, you are long interest rates as this lowers their value aiding your short position. However, Rho's relative importance vs. volatility diminishes as your time frame shortens. As for a volatility spike affecting the value of your puts, it will have the exact same effect on your calls. There is absolutely no difference in the positions except ( as Nvaro noted) your interest rate exposure. But the interest rates used by market makers are those implied in the treasury rates, so there's no point in worrying about it unless you know something about rates. If you do, you should be a bond trader, not a stock trader

It's critical to anyone trading large rho. My point is to trade both if you're trading large notional. I've made money selling equity boxes during the run from 5.25% to 2.00% on FF. An order of mag more than could be earned going long GEs.