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

[Profitaker]

Agree with the above that buying stock for the sole purpose of writing Calls isn't the smartest option play available. However it does keep the broker in champagne !

However, and this is the BIG difference; if you already own a stock for the long term, then writing Calls against it, in the right circumstances can be a good income generator. This is very different to what's generally been discussed above.

 

[MajorUrsa]

Quote from Profitaker:

Agree with the above that buying stock for the sole purpose of writing Calls isn't the smartest option play available. However it does keep the broker in champagne !

However, and this is the BIG difference; if you already own a stock for the long term, then writing Calls against it, in the right circumstances can be a good income generator. This is very different to what's generally been discussed above.

That is right, but to me that poses the enormous question: why would you 'already' own stock for the long term if it doesn't do anything, or so little that writing options should be used for income. Why not sell it and buy something better?
And don't say you keep them because you bot them higher!

Ursa..

 

[Profitaker]

Quote from MajorUrsa:

Why not sell it and buy something better?

There maybe tax issues. Actually there could be a number of reasons as to why you wouldn't want to sell...

 

[ktm]

...and the call allows you to say that you would want to get rid of it at X price, but get paid a small sum if we don't reach X price.

 

[MajorUrsa]

Quote from Profitaker:
There maybe tax issues. Actually there could be a number of reasons as to why you wouldn't want to sell...

Possibly, I saw discussions about that but never really got involved because of different laws where I live. Isn't the fact you are delayed by tax to get rid of stock an even better reason not to do CC's but write puts instead?

Quote from ktm:
...and the call allows you to say that you would want to get rid of it at X price, but get paid a small sum if we don't reach X price.

Maybe, but having a long-term investment called away after it finally begins to move doesn't sound right to me.

Ursa..

 

[MoralHazard]

Quote from sle:

How in your opinion a "covered call" is different from a GTC limit sell order?

That's, I think, a very good question.

First: selling a covered call means you you retain the downside risk, but give up the upside, for which you receive premium. With a GTC limit sell, you transfer the full risk and so its "worth nothing" (security is M2M by that transaction), regardless of what triggered the sale.

Second: options are supposed to be replicable with a combo of cash and the underlying, in [edit: principle] (barring jumps, commissions, sudden changes in vols, etc). However, you always hold some (Delta) of the underlying (for a call), regardless of where the price is relative to the strike.

Third: So, how is it that I can't just use a limit/stop replication technique? eg for CC, put in a limit sell when you're below the strike, and limit buy when you're above (take rf rate to be zero to simplify the argument). I have an arb: I sell the CC for a premium and use this replication to hedge myself costlessly.

I'm not sure, but I think you'd lose mainly on slippage at the strike. "Transactions costs" is another, but only as it pertains to inventory risk (as opposed to mere old "rents" that go toward your broker's Ferrari Fund)

Any comments?

 

[Profitaker]

Quote from sle:

How in your opinion a "covered call" is different from a GTC limit sell order?

The difference is that with a GTC sell order you receive no additional premium, whatsoever. Whereas selling a Call option which is sold against stock that you already own then you do receive premium, and this regardless of whether or not the "limit sell" (stock being called away) is executed.

Don't get me wrong...... I would never advocate deliberately entering into buy-write as a stand-alone strategy. But as above, if you own the stock ANYWAY, and intend to do so for WHATEVER reason then it's not such a bad practice, IMHO of course.

 

[sle]

Quote from Profitaker:
The difference is that with a GTC sell order you receive no additional premium, whatsoever. Whereas selling a Call option which is sold against stock that you already own then you do receive premium, and this regardless of whether or not the "limit sell" (stock being called away) is executed.

Exactly my point. By setting a limit order you give your broker the optionality for free, while if you are selling covered calls or naked puts vs pruchase, you do get paid for the convexity. The only difference that I'd add (and it is an important difference) is the fact that a limit order can be canceled should the market change.

Quote from MoralHazard:
Third: So, how is it that I can't just use a limit/stop replication technique? eg for CC, put in a limit sell when you're below the strike, and limit buy when you're above (take rf rate to be zero to simplify the argument). I have an arb: I sell the CC for a premium and use this replication to hedge myself costlessly.

Hehe. Long time ago this "heding scheme" was proposed to me as an interview question regarding stochastic integration. Essentially, no matter how frequently you re-hedge, you can't match the stochastic path (slippage etc.). But you said that.

Quote from MoralHazard:
First: selling a covered call means you you retain the downside risk, but give up the upside, for which you receive premium. With a GTC limit sell, you transfer the full risk and so its "worth nothing" (security is M2M by that transaction), regardless of what triggered the sale.

True, the optionality is not identical, as your order would only be executed at or above the limit. But that would require a very honest broker. In real life if you have a limit sell and the market rallies through it, the broker would miraculosly "buy" your order at the limit price for his own book.

 

[MoralHazard]

Quote from sle:

True, the optionality is not identical, as your order would only be executed at or above the limit. But that would require a very honest broker. In real life if you have a limit sell and the market rallies through it, the broker would miraculosly "buy" your order at the limit price for his own book.

Agreed, so no free lunch. Risk really is risk, and you cannot avoid paying to get rid of it. Whether or not you pay a "fair price" depends on the efficiency of the market in that security at that time. Conversely, you get excess return for holding (economic) risk, or for making the markets more efficient.

Since I could not trade my way out of a greenhouse in full daylight, I'm grateful to all those who ensure that I'm not taken advantage of too much...

[edit: hey there's an example - a 3 point gap down in DELL]

 

[srolle]

it isnt identical. you could get early exercised on your calls before a dividend. you will obviously not get exercised on your puts before a dividend.