Why is selling a covered call identical to selling a put?

Quote from ktm:

I think part of the issue may be the intended audience. Most of the trading public doesn't deal in options. Many may not have the right or ability to write uncovered options in their accounts. Since owning stock is so basic, it is easier to explain the covered call concept to people. I would imagine no one wants to be deemed responsible for a blowup for showing them how to sell premium. They get carried away and forget that they need to be able to buy the stock when assigned and then get in trouble.
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I think it is even more basic than that. Many ppl do not view their owned stock as 'at risk'. They eg. think that they will only lose on the (lower) stock when they sell it again. Until that moment they will hold on and will not regard the current 'paper' loss as real.

Instead of explaining this to their clients, eg. by asking them if they would buy the stock now if they didn't own it (and thus sell it if the answer is no), they take the 'given' stock position as departure point.
Seen from that point, the risk on the stock is a accepted anyway, so the written call is for free.

I've encounterd many who didn't understand any of the earlier explanations. They first have to understand that there is no such thing as a paper loss.

Ursa..
 
Quote from smilingsynic:

Not quite. Synthetically, a buy/write call is equiv to writing a put, just like sell/write put is equiv to writing a call.

The differences between the strategies, assuming equal premium, are in (1) margin required (selling a put requires much less margin): and (2) transaction costs. Selling a put is a smarter move generally becaue you are dealing with at least one less commission and at least one less bid-ask spread.

The option buyer is actually the borrower; the writer is the lender.
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There is one big difference when it comes to managing the risk of the situation:

If you have a covered call ( buy-write ), you own the shares of stock, and there is no real risk related to the option since if the option is exercised, they simply call away your long stock and the position is still a profit at the end. It is also not as easy to get into an unmanageable situation when the stock drops because even if the stock is fully margined, it would take a huge move in the stock ( ie 50% drop ) to cause a margin call, plus you keep the call premium which provides a small offset against the loss.

When somebody starts trading naked puts, they often succeed repeatedly selling a small quantity, then after the practically inevitable series of small successes watching the puts expire, they tend to start increasing the quantity of puts sold, potentially putting themselves in a situation where they can sustain a large margin call in the stock plummet scenario. Think 1987 crash, 1989 mini-crash, 1997 currency collapse, 1998 drop in the fall, April 13, 2000, etc. Most people writing naked puts are only putting up the minimum margin to maintain the position, and are not really considering the full cost of buying all the stock in the worst case scenario. This then becomes like Russian Roulette with your account. Click....Click.....Click.....Bang - Dead. The only question is how long it takes for the bullet to go off.


If you always maintain enough cash to purchase the stock in the event the puts are assigned, then I agree that it is similar in nature. But human nature being what it is, the covered call situation is much safer.
 
I always sell a put on the rare-occurence I intend to buy stock as an investment over trading. Why not reduce your cost basis on a long-term investment? In any event, the synthetic[p/c parity] dictates they're fungible.
 
Quote from areyoukidding?:

What happens if your stock goes down? Lets say u bot stk at 100 and wrote call at 2, if stock goes down below 98 you are losing pt for pt. now lets say stk is 100 and you just wrote a put for 2, if stock goes below 98 same thing.
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I assume you are referring to the premium of the puts and calls, not the strikes.

If you are a mutual fund with a large position in a slowly moving stock you sell calls against the position. Suppose the stock is at 100. You sell the 105 call which is three months out for $1.00. The stock does not hit the 105 exercise price and the option expires. The fund has just picked up an extra 1% on that position. Repeat three more times during the year and you've got 4%. If the stock moves up and is called you get the appreciation to 105 plus the $1 premium making it an equivalent sale of 106. If the stock is still a good investment you rebuy the stock at less than 106 you are still money ahead. If the fund is not worried about taxes it is a good deal. If they worry about tax passthru to the fund holders they would probably just enjoy collecting the option premium.
 
Quote from smilingsynic:

Not quite. Synthetically, a buy/write call is equiv to writing a put, just like sell/write put is equiv to writing a call.

The differences between the strategies, assuming equal premium, are in (1) margin required (selling a put requires much less margin): and (2) transaction costs. Selling a put is a smarter move generally becaue you are dealing with at least one less commission and at least one less bid-ask spread.

The option buyer is actually the borrower; the writer is the lender.
More...

Not quite - you agree, or not quite - you don't? Put-call parity

Put = Call - div discounted Stock Price + present value of strike price

So, ignoring stock dividends, for example, the put seller only has to set aside the present value of the strike and comes out ahead by the interest earned. I think you allude to this when you mention margin, so perhaps we are in agreement. PL diagrams as generally used do not incorporate discounting.

The commission difference is another issue, but in principle a brokerage could (should?) offer a buy-write as one transaction.
 
I think retail brokers tend to push the covered call strategy. It's a good way to keep generating commish from accounts that would otherwise just be fully invested in slow movers and sit there. Plus, there are a lot of investors who are intelligent and successful in their own fields, and that kind of person likes to feel they are exploiting the ignorant masses by selling premium to hopeless dreamers who don't understand that "90% of options expire worthless" .

You hardly have to be able to recite Natenberg from memory to know a cc is equivalent to a short put. But the average retail customer reasons that he will keep the underlying stock for the long term, so why not generate some income by selling OTM prem to suckers. Plus, they are getting a whole buck or two downside protection! As a bonus, it's a conservative strategy! No speculating here.

My experience has been you make most of your money in stocks by catching big up moves that come out of nowhere. If you have capped your gains by selling calls, you forfeit those moves while still being fully exposed to the downside. Most of the retail accounts doing this are not sitting there with a hair trigger to unload the underlying if it drops. So they are exposed to "down big", even as they have given away the prospect for "up big."
 
Quote from MoralHazard:

Not quite - you agree, or not quite - you don't? Put-call parity

Put = Call - div discounted Stock Price + present value of strike price

So, ignoring stock dividends, for example, the put seller only has to set aside the present value of the strike and comes out ahead by the interest earned. I think you allude to this when you mention margin, so perhaps we are in agreement. PL diagrams as generally used do not incorporate discounting.

The commission difference is another issue, but in principle a brokerage could (should?) offer a buy-write as one transaction.
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Yes, I agree with you. As I mentioned, selling puts makes more sense for many reasons, including margin.
 
Quote from AAAintheBeltway:

I think retail brokers tend to push the covered call strategy. It's a good way to keep generating commish from accounts that would otherwise just be fully invested in slow movers and sit there. Plus, there are a lot of investors who are intelligent and successful in their own fields, and that kind of person likes to feel they are exploiting the ignorant masses by selling premium to hopeless dreamers who don't understand that "90% of options expire worthless" .

You hardly have to be able to recite Natenberg from memory to know a cc is equivalent to a short put. But the average retail customer reasons that he will keep the underlying stock for the long term, so why not generate some income by selling OTM prem to suckers. Plus, they are getting a whole buck or two downside protection! As a bonus, it's a conservative strategy! No speculating here.

My experience has been you make most of your money in stocks by catching big up moves that come out of nowhere. If you have capped your gains by selling calls, you forfeit those moves while still being fully exposed to the downside. Most of the retail accounts doing this are not sitting there with a hair trigger to unload the underlying if it drops. So they are exposed to "down big", even as they have given away the prospect for "up big."
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I hate the term "covered calls." It sounds so benign, like your investment is being tucked in a blanket.
 
Quote from smilingsynic:
I hate the term "covered calls." It sounds so benign, like your investment is being tucked in a blanket.
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How in your opinion a "covered call" is different from a GTC limit sell order?
 
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