Registered: Aug 2006
05-12-08 09:38 PM
Quote from 1Reason:
Good question, I generally enter into and exit out of covered trades first through the option leg of it due to liquidity issues.
I try to sell on the ask and buy the bid even with options.
If a trade has gone against me over 2% I start looking to get out or at least look at it and see if I want to get out. I don't have a fast and hard rule on stop losses.
Of course in a fast moving market it can get costly to try to get out of both a stock and the options.
Actually I am sure people must be selling options and using the premiums collected to determine their stop loss.
For example, you buy 100 x MIR @ 40 and sell a call strike 45 @ 0.60.
You can then place a stop on the stock at 39.4 and if the move goes against your position, the worst scenario is that you end up break even (100 x MIR @ 40 - 100 x MIR @ 39.4 = 0.60 x 100 premium collected from the call).
Obviously, you would have to analyse the volatility of said stock, as a 0.6 stop might be too tight and could leave you stopped out - the result being you end up with a naked call.
Is this reasoning correct? Is it a viable covered call strategy? What other potential drawbacks does it have that I have not factored in?
We should ask the gurus over at the option forum..