[RT] Selling Covered Calls

[ric ingram <ringram@xxxxxxxxxxxxx>]

Hi,

recently, related to QQQ, there has been talk of covered call selling.

Selling covered calls is a popular strategy, often recommended to 
conservative investors in stocks.

Like all strategies there is a time, place, and appropriate audience.

If you have studied options you will know about put-call parity.   This is 
the equivalence equation that  helps keep the prices of puts and calls at 
the same strike at the same maturity strongly tied with each other - 
otherwise arbitrageurs, looking for a risk free (but not capital free) 
profit, enter the market to help make the prices come in line within the 
limits of trading expenses.

The equation that relates the prices of a put (P) and a call (C), at the 
same strike and the same maturity to their underlying security (U) is:

U = C - P

Reassembled this is U - C = -P

So holders of the underlying who sell covered calls are performing the 
equivalent of selling a naked put.

Now most conservative investors would run a mile (rightly or wrongly) if 
you suggested they sell naked puts, but that is what they are doing when 
they sell covered calls.

It is truly amazing how greed can get some people to initiate positions 
that if they understood their fear would stop them doing.

But some people have a real perception problem - and do not know it.

It is only reasonable to point out that given that you intend to hold the 
underlying, selling a covered call actually reduces your exposure to a big 
fall.   So if you were going to hold the underlying anyway, selling covered 
calls can be considered a conservative strategy.

However if you do not hold the underlying or do hold it but do not intend 
to keep it, buying the underlying and selling a covered call is the same as 
selling a naked put.

Paradoxically, selling naked puts is actually lower risk than holding the 
underlying if you allocate the same capital as you would have done for 
holding the underlying.

But rationality is rarely a bedfellow with fear or greed.

Unconditionally yours, Ric.
www.traderscalm.com 


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