Please ask your broker the difference between a covered call and a naked put. I'd love to hear what he has to say.
The broker: "A covered call generates 2 commissions for me." "A naked put only generates 1 commission." "Thus, the covered call is a much better strategy."
Actually the covered call generates 3 commissions in most cases. Buy the stock, sell the call, the sell the stock again for less than I paid for it.
Less sarcasm and more reality. Fidelity will allow most anyone to write covered calls. That is the lowest 'level' of approval. They even allow it is IRA's. But if you look at the chart writing cash covered naked puts is on the highest tier and not allowed in IRA's. Anyone who knows anything at all about what they are doing in options will know that as far as a risk profile a covered call is synthetically the same as a naked put. But most brokers will try and scare the beejesus out of you about how risky a naked put is versus how safe a covered call is. The biggest difference for a broker between a cash covered naked put and a covered call is that they get much less commission. You are taking just as much risk for a naked put as a covered call.
i've had this argument with client from previous days who sits on the board of a broker. i think the biggest problem is the way covered calls are portrayed. the average investor kinda buys into the falsehood that covered calls protect a portfolio. most view covered call writing as what *smart* conservative investors do. i've had many *smart* conservative investors brag to me about the 'best of both worlds' covered call strategy. hell, when i was a rook @ mother merrill, that's pretty clsoe to what we were taught. i didn't know dick, and went up to my instructor to have him explain to me what i wasn't understanding, cause i saw it as a false sense of security- he said i was right if i was talking about a big drop- duh. next day, to his credit, he explained that the strategy did not provide true protection in a large fall. a lot of retail brokers only really get it after their first implosion.
When a person writes an option, he must be covered or put up margin. For calls to be covered, he can have a position in the stock or in another option with the same expiration or longer and the same strike or lower. Without these, the writer is said to have unlimited risk. So "covered" for margin purposes means that the brokerage firm is not at risk. The brokerage industry has very cleverly mutated the meaning of "covered" by defining that the writer who has either of the above is a "covered writer", implying that there is little or no risk. In their words, they say that "the covered writer is protected against loss." In the immortal words of Danny DeVito, "Heh, heh, heh!"
Theoretically...on paper...yes. But think about the risk profile for the average investor or trader, and you'll appreciate more the reasons for naked selling restrictions in a brokerage account. With a covered call, the investor must own the underlying to write the call. So they are aware from step one of their account exposure, because the underlying is there clearly in the account. But naked puts can be very dangerous in the hands of the inexperienced, who often fail to calculate the downside and their total market exposure when the underyling tanks. For that reason alone, there is quite a difference in risk to the uninitiated. And here I define uninitiated as those who have not yet had their ass handed to them when a naked put explodes. That is not to say that I am a fan at all of covered calls. I think that the entire concept of capping potential gains on a long stock position is plain stupid, as most long strategies need a strong gain now and then to overcome the inevitable losing positions.
In theory and in practice. Regardless of how much the underlying tanks, the net loss is the same whether it is a cash covered naked put or a covered call. The net worth reduction is still the same. The only difference is whether you sell the stock for xxx less than you paid for it or they collect xxx directly from your account. The real problem is that people are investing in things of which they do not understand.