New to options, quick question..

Discussion in 'Options' started by frostengine, Oct 29, 2006.

  1. I have a few questions about options.

    Ok, I know for a covered call you own the stock and then sell a call at some strike above the current stock's price. If the stock is above this price at expiration you sell it at that price. What is the margin requirments for this? I am assuming that there would be none besides the requirements for the origional stock is this correct?

    Now the real question I wanted to ask. Is there a similar situation with puts? Lets say you are short a stock, can you then sell a put? So then if the stock is less than that strike at expiration you have to buy it... all that is fine, but the question is what is the margin like? is the margin similar to what happens in a covered call?

  2. Hi,
    Long stock and short call (aka covered call) is synthetically the same as a short put (a limited risk strategy, lol) - in your case the short call is covered by the long stock and thus there should be no need for margin.
    In your second example you have short stock and a short put position which is synthetically the same as a short call. A short call (considered as an unlimited risk strategy) has margin requirements and therefore your position will also (man, my syntax is going from bad to worse, lol). The amount of margin varies between brokers.
    An easy way to work out these basic synthetic relationships is to use the following:
    u + p = c
    where u is underlying
    p is put
    c is call
    Then simply manipulate the equation to get the position you want.
    For instance the covered call would be:
    u - c = - p
    where '-' denotes a short position.
    Similarly your second question would be answered by:
    - u - p = - c
    Back to your margin question. The margin for your short stock/short put (aka synthetic short call) will be different from the covered call because, as I mentioned earlier, the covered call is already covered by your stock, thus the term 'covered call'. Some brokers require a minimum account size (apart from the margin requirements) before letting you trade 'unlimited risk' positions like naked short calls.
    Quick question but long answer :)
    Daddy's boy
  3. The Calls you sell can be any strike you like, doesn't have to be above the price of the stock. The higher the strike you choose to sell the more premium you will collect, but the greater chance of having your stock "called" away.

    If the stock is higher than the strike of the options then the options expire worthless, you keep the stock and the premium collected from selling the options - your example of having to sell the stock is wrong.

    No margin required, for every 100 shares you own you can sell 1 contract.
  5. This is a familiar argument, about the short put having limited risk versus the short call being unlimited. In theory it is true but I'd rather be short calls than short puts, if I had too choose. Let's get into this another time :)

    The margin question is best put as how much of my capital is locked up in the position and unavailable for other purposes:
    • Buying stock will of tie up a certain part of the real cost of the stock, depending on the broker. Selling short calls will also demand a margin, but since you are 'covered' by the stock no more margin is needed above the capital involved in owning the stock. Selling the equivalent short put does need the margin, because it is really naked. The margin for the short put and covered call will be different but similar.
    • Selling stock short will need margin. For many brokers the margin needed is about the same as the capital needed to buy the stock long. Selling a put next to it would again need a margin, but since the put is 'covered' by the short stock no additional margin would be needed. Selling the equivalent short call would need a full margin, since it is stark naked, which should be about the same as for the 'covered put'.
    Since there is no real statistical difference between going short and long both strategies, and their synthetic equivalents will need about the same margin. Of course, in practice, there are differences, also depending on brokers. An important issue is that credits received by selling options can not create a negative margin.

  7. I was giving you the benefit of doubt :)
    daddy's boy
  8. Let's assume the following:

    Long stock at 50 -
    Short call premium 5 - 50 basis (just time value)
    BEP is 45.

    If I decide to close my position at a stock price of 48 (before expiry) why wouldn't I make profit?

    Is it just b/c I have to buy the call back and won't be able to cash in the total of 5 bucks? I would be making money on theta (and/or vega). But the chances that I'll buy the call back at a lower price than 3 is almost zero. Right ?

    Taking commissions into play it's a non profitable trade until expiry.

    Thanks for any comments.

  9. A covered call is the same exact trade as selling a short unprotected put naked. Before doing something like this I would highly recomend investing in a seminar or some text books along with paper trading. A collar is a much better alternative as it protects the downside risk. :D
  10. Hi
    A number of factors determine the answer to your question. Time decay will be in your favour if your short call is otm, but will work against you if it goes itm. However, I'll confine my reply to your scenario of stock at $48.
    If you close your position prior to expiry then your profit (if any) will be as follows:
    1. sell stock at 48 (bought for 50) - gives you a $2 loss
    2. buying back the short call (I assume it was written otm when you opened the position). The cost of this will depend on a number of factors (strike price of your call, price of the underlying stock, time left to expiry, volatility, interest rate and dividend - all part of the pricing model) but should work in your favour as long as there isn't too much time left to expiry. However, you may end up having to pay more than $3 to buy it back, eroding any profit. However, this is not a very likely scenario unless the call goes itm (in which case you can let yourself be assigned and thus get your max profit) or iv spikes. A much more considerable risk is if your stock drops to less than $45. Then what will you do?
    As you have pointed out, the BE is only at expiry and is somewhat irrelevant (I should say different) prior to expiry.
    daddy's boy
    #10     Nov 12, 2006