OC You make valid points in that an OTM naked put might be the better trade. But it is not the equivalent trade. Sometimes it might be quite similar, but not equivalent. Similar means slightly (or hugely) different risk profiles. Equivalent means identical risk profiles. PayS, In your example you spoke of owning a $50 stock and selling the 55 call for $2.50. Max gain on this position is underlying >$55 at expiration. Let's assume at expiry the underlying is at $55. You get the $5 increase in stock price, and you keep the $2.50 premium on the calls. This position makes $750. On the other hand, let's say you sold the 55 strike put for $7.50 instead. At expiry if the underlying is at $55 you will get to keep the entire $750. So you see the max profit is exactly the same. Now let's say that the underlying dropped to $47.5 at expiration like you said. Your stock will have lost $250 because you owned 100 shares, but you made $250 on the calls you sold against it. So as you stated you are at break even at 47.5 What if you sold the 55 puts instead? You are $7.50 ITM at expiration, so that would be your loss. But you collected $7.50 in premium for each option. So again you made $750 and lost $750. You are at break even. You can run the analysis with whatever expiration price you want and the result will be the same. The two positions are identical. That is true except when it comes to leverage. You were wondering about my numbers. $750 return (less $5 commiss) on a $2,375 investment is about 31.4% return. Assuming you scaled the position each time there were gains and you could do the position 8 times a year, you'd have a return of 787%. In other words a $100K investment would be worth $887K after one year. Assuming max profit each time you closed the position. OTOH, the naked put portfolio numbers: $750 return (less $0.75 commiss) on $800 investment is about 93.7% return. The other $1,575 you didn't tie up in the position can be invested in fixed income. We assumed a 5% return or a 0.625% return each period. Assuming you scaled the position and performed 8 times, the annual return would be 820%. Your $100K account is now worth $920K. That is a difference of $33K which is only 4% of the yearly gains (33K/820K) but when you compare it to the initial port size, that is an extra 33% return. Show me an investor that doesn't care if you throw away an extra 33% gain each year that was otherwise free money. As OC said, many brokers will allow you to hold fixed income investments against your naked puts. There is really only one reason to do the covered call instead of selling the put. If the account is an IRA account then it is actually prohibited from the naked put. Some people think the regulators don't realize the equivalence of the two positions. Personally I think they are trying to force people to actually take possession of the stock to keep the market progressing.
That is my point that naked puts and covered calls are not really used the same by people so you cannot just make an equivalent argument. Most people do ATM or slightly OTM CCs. I think if you compare it to using OTM short puts and adjust the position size, the OTM short puts is better for reward, breakeven and margin. What happens is you get an argument that does not make sense to a newbie without further explanation. If a CC = naked put in everyway, then you would have no reason to argue for naked puts over CC, they would be equivalent in all aspects. But they are only equivalent in terms of risk/reward AT THE SAME STRIKES. However margin or up front capital requirements are different for a long stock/short call versus the short put so there is one difference right there. Another significant difference which is what I am trying to point out is that people tend to choose certain ATM/OTM strikes for the CC and OTM strikes for the short put. In practice most traders would not use a short put at the same strikes they would normally do a CC position. Now granted you can simply use the ITM strike for the call and long stock to replicate OTM short put but the short put will still have an edge in margin requirements and ease of adjusting or closing out as it is one position. So my point is that it will not make any sense to a newbie to argue something is a synthetic equivalent and then state that it is best to choose one over the other- that contradicts, in a newbies mind, the very argument you are trying to make. The two positions are synthetically equivalent ONLY with respect to risk/reward at the same strikes. When you take into account margin and strike selection and use of funds not tied up in stock, you realize why the short put is a better way to approach these positions and it makes more sense when you are trying to explain it.
I know what you are trying to do OC, but I think that in several pages worth of posts I provided adequate explanation as to how they are the same and how they are different. I just think that a recommendation to sell an OTM put instead of an OTM CC is even more confusing and at times dangerous. I'm talking about something that is the same position with better leverage. You are talking about something that is completely different with better leverage.
I was not making any recommendations just clarifying important differences are not just in the margin and single position but also in strike selection. I never made a generalizations that OTM puts better than OTM CCs, I said that you can show the utility of naked puts not only comparing same strikes but also comparing how they would be actually used. naked puts are often sold OTM and you can get the same or better premium you would be looking for with a CC with less margin and a lower breakeven point. A different way to make the same argument I suppose . Not disagreeing with your points .
I haven't yet read all the posts since I'm running behind (as usual), but I think I am being more concerns with stop-loss methodology which plays a large part of my strategy. I'm thinking like this: high-yield type CC stocks will jump (quite a bit) and if this is against me, I don't have the luxury of thinking and holding to maybe cut bait later. When my positions move against me it is almost always for a reason that my not be apparent at the time, but will eventually be made plain. That being said an ITM or OTM or ATM put will jump with the stock price in large percentage-wise (to the option sell price) terms, but perhaps not as much in relation to margins. Still I am at some point more likely than not to stop-losses and covering my naked put options will be costly. I'm not the senior citizen (not referring to you) using CC to generate extra cash. I don't do EFT's or Dow stocks and I don't sell LEAPs or med- to long-term CC's. I have a stict stop-loss methodology and buying power and naked insruments may not work for me. But I need to read all you wrote. You see when IOC drops to 33-34 in two days, my naked 35's are going to substantially jump. 30-50% per put is too risky even if mitigated by buying power I will need to cut bait at some point and take a loss. Will it be less for naked put sells that CC...I will see. I just don't hold on thinking these will hopefully erode worthless by expiry. I leave that up to the speculators. The ones I am actually making money from by selling the call options. Gotta go but will read thx
Dont get hung up on percentages since you are comparing different positions and money at risk initially, look at the actual risk and money lost.
YOU ARE SHORT a naked put when buying stock and writing a call. Do you assume the relationship is nullified simply because you're too thick to grasp the concept?
Ok for ever covered call trade I can log 1-3 naked put trades and look at the risk though the holding period and see what jumps out. May be equal or less risky feel. Easier to manage and less comm and scoop of free money. I'd really like to understand how you guys calc that roi stuff and get these (theoretical) 800% per year total. Then I could get my arms around why this dictation is useful PS
Lol.... YOu see paysense... the point we are making is that if you are already short the put synthetically, why not short the put directly and choose a better position to begin with in most cases. Especially if you are doing buy writes.
I think Cache is right, I confused you too much with OTM puts and postion sizing. Just compare the ATM CC with the ATM short put and what your margin is and how much you could add to your performance by putting the idle cash in other secure investments.