Newbie options journal

backflip · Oct 5, 2006

Very insightfull, thank you. That makes complete sense. So it is better to just do the naked put since it requires less margin. I think I am leaning more towards credit spreads; this way I wont be blown out on a gap or fast moving stock.

Quote from momoneythansens:

Sure, let's assume that synthetic equivalents can be substituted for the real thing at any time. At all points on the risk map they are identical.

Let's say you did your covered write. Now, when you aren't looking, I sneak into your account and switch your covered write position with a naked PUT.

Pretend that you don't look at your existing portfolio to make any trading decisions moving forward. Instead you look at the stock price and options chains to see current values of various options. Hope you're still with me.

Now, looking at your adjustment strategies that you outlined: Say you want buy back the call if the stock drops and sell it again on a bounce. What steps do you take?

1) Buy CALL on dip.
2) Sell CALL on bounce.

There's nothing to stop you performing these two trades regardless of what is in your portfolio. In fact, you don't know that you are simply buying a CALL rather than buying back a short CALL. It's the same trade.

With a covered write, when you buy back the CALL you are left with long stock.

With a naked PUT when you buy the same CALL you are left with synthetic long stock.

i.e. you are left with two synthetically equivalent positions. As we have already established the two positions are interchangeable.

If you perform the same action to both positions, you will be left with two further synthetically equivalent positions and so on...

In short, whatever adjustment strategy you have in mind for the covered write can be applied exactly the same way to the naked PUT.

Why is this helpful? When you view the covered write as a naked PUT it becomes obvious that a drop in the stock actually harms the position. It doesn't help it. Although you are realizing a gain in the short CALL (I presume that is the motivation for buying it back), you are losing much more in the stock. Overall there will be a net loss. Buying the CALL then turns the position very bullish (long stock).

Hope that helps.

MoMoney. [/QUOTE
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backflip · Oct 5, 2006

Got it. I really appreciate the feedback.

Quote from spindr0:

Quote from backflip:

Is it not easier to adjust a covered write that is going against you than a naked put? With a covered write, I have the option to roll down, or out a month and down, and it seems that with puts it is much more difficult to roll down or out and down and still have profit potential. Also, with a covered write, I have the oppurtunity to buy back the call if the stock drops, and sell it again if the stock bounces for more profit--this adds more risk I know, but with a naked put this oppurtunity does not exist. Please comment as I am still learning.
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Whatever you do with calls can be done with puts and/or stock. Regardless of whether your initial position was a CC or a NP, you can buy the Oct 17.50 call in both cases (to close with the CC and to open with the NP) and still have the same result. If you aren't familiar with synthetic equivalents, this can be a bit daunting.

Rolling down will be the same and perhaps easier to understand. For simplicity, let's pretend no dividends or carry cost so that I can make up workable option numbers where puts and calls have the same premium ATM.

For the CC, you buy the XYZ at 17.50 and sell the Oct 17.50c for 1.25. If exercised, you make 1.25 and if XYZ drops, you own it at 16.25

For the NP, you sell the Oct 17.50p for 1.25 with the same result. If it expires, you make 1.25 and if XYZ drops, you own the stock for 16.25

Now supoose XYZ drops to $15. You're down $1.25 on either position. Suppose the Dec 15c and the Dec 15p are going for 2.00

For the CC, you roll: Buy back the Oct 17.50 call for .25, pocketing 1.00 while carrying a paper loss of 2.50 (1.50 net loss) and you sell the Dec 15c for 2.00 and you now have a potential profit of 50 cts and a new cost basis of 14.50

For the NP, you buy to close the Oct 17.50p for 2.75 for a loss of 1.50 and sell the Dec 15p for 2.00. You now have a potential profit of cts and a new cost basis of 14.50 if put the stock.

Same result either way. The only thing that you have to watch out for is wash sales but that's no problem if you close the position by 12/31

Clear as mud? (g)
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backflip · Oct 5, 2006

Is there not an oppurtunity to profit on the put if NITE drops?

As mentioned by momoney, the Oct 17.50 covered call (CC) is synthetically equal to a naked Oct 17.50 put. By buying one Oct 17.50 put, you have morphed into a conversion which has locked in the .80 gain. You now have a long synthetic Oct 17.50 naked put and one long Oct 17.50 put which means you make nothing more than .80 nomatter how high the stock soars or drops. If that was your objective, rather than adding another leg and two more commissions, you should have just closed the position.

momoneythansens · Oct 5, 2006

Quote from backflip:

Very insightfull, thank you. That makes complete sense. So it is better to just do the naked put since it requires less margin. I think I am leaning more towards credit spreads; this way I wont be blown out on a gap or fast moving stock.
More...

Not necessarily less margin under regulation T as the naked PUT will be cash-secured. However, it requires less legs and less commissions versus the covered write. It's also arguably clearer or more transparent where your risk lies.

It's interesting that you mention the risk of being blown out on a gap when looking at it as a naked PUT but perhaps those thoughts didn't cross your mind when you were looking at it as a covered write despite being the exact same position. I'm just speculating though.

Being able to view your position in its simplest form by dissecting it through substitutions and synthetics is a great tool to have at your disposal.

Suggest you consider having a look at Charles Cottle's book: Options Trading: The Hidden Reality

Many find the content difficult, but persevere, it's not really and will pay dividends.

momoneythansens · Oct 5, 2006

Quote from backflip:

Is there not an oppurtunity to profit on the put if NITE drops?
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You'll profit on the long PUT....but you'll lose on the short same strike PUT (long stock + long CALL)!

Long PUT + short PUT = no position/locked position.

Load the position into some analysis software and you'll observe an expiration risk profile of a horizontal flat line. The vertical displacement of the line is equal to your locked in PnL.

Again, it's about transparency. View your covered write as a short PUT and you'll realize that your long PUT is simply offsetting your existing position.

Good luck!

MoMoney.

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