Are selling verticals the same risk as covered calls?

Discussion in 'Options' started by traderjb, Apr 24, 2008.

  1. I was having lunch with a fellow trader friend of mind and we brought up something interesting. He kept arguing that selling a vertical has same risk as initiating a covered call. I thought he was nuts.

    He cited an example selling an OTM SPX vertical and using the return on margin as the same as a return on a stock's call. He said that the worst case is already limited at the end of the vertical where one buys the option. In a covered call, the worst is the stock goes to zero. But I asked him what if you purchased a high priced stock, say around $100/share? Well he kept saying that one could lose that much in the margin requirement in the vertical if it's structured that way. I'm still not sure, I've done OK with covered calls, never initiated a short vertical. Well, I know the good folks on Elite Trader could clarify this for me. Any help here would be greatly appreciated.
  2. Let's look at this logically.

    So, yeah. It's pretty clear. Both positions have the same risk, to the extent that buying a call has the same risk as buying 100 shares of stock.

    Which, for the sacrasm-impaired, is not at all.
  3. Div_Arb


    In selling a vertical call spread, you are short the lower, where with a covered call, you are long the lower. You loose real money if the stock rises past your short strike on a vertical, where you loose opportunity money when the stock rises past short strike with a covered call. In other words, you don't loose real money with a covered call.

    Selling a naked put is similar writing covered calls. Perhaps your friend is confused.
  4. Which verticals are you referring to? ATM, OTM, ITM? Calls or puts? Which time frame is the long call in the vertical, which also depends on volatility?

    You can view covered call as just an example of call spreads when the strike of the long call is zero, and expiration time is infinite.

    Personnally, I do not like covered calls as they are limited in return. If you sell at the money, for a typical vol, you may not do better than 30% (not compounded) annually. Are you doing better than 30%?
  5. Verticals are synthetic collars:

    Long call at X
    Short call at Y


    Long stock
    Long put at X
    Short call at Y

    Collar dissection: long stock + long put = synthetic long call.

    Synthetic long call at X + short call at Y = synthetic vertical.

    What options does your friend trade? I'll be happy to cross some trades with him.
  6. :)
  7. rosy2


    then whats this?

    Long call at A
    Short 2 call at B
    Long call at C


    Long stock
    Long put at X
    Short call at Y
  8. A long fly at ABC and a bull collar/vertical at XY.
  9. I think what you mean is: Is BUYING a Vertical Call Spread like writing a covered call? The answer then becomes: sort of. If you buy a Vertical Call spread you are limiting your upside (just like a covered call) but you are also limiting your downside which is the major difference. Also since options are cheaper than the shares of stock you can carry more positions with a vert than you could with a covered call with the same amount of investment.

    With this you would buy a call at a specific strike and write a call at a higher out of the money strike.

    The absolute closest thing to a covered call (as Div_Arb said) is selling a naked put. With this trade you are limiting your upside while NOT limiting your downside (unless you use a stop loss).
  10. More so in that they are equivalent over duration provided rates/dividends are static.
    #10     Apr 25, 2008