risk covered call

Discussion in 'Trading' started by luofeiyu, Feb 16, 2012.

  1. luofeiyu

    luofeiyu

    hi,everyone:
    it's said that covered call is risk-less.
    i found it's not ,there is risk in the covered call
    let's suppose:i have 100100 usd ,i bought 100000 shares A stock,1 usd per share, pay 50 usd commission,then i write covered call,1000 contracts , strike price is 2 usd ,the call option is 0.05,i pay commssion 50 usd too.
    now ,in my account ,there is 100000 shares of A stock ,1000 contracts,there is no cash in my account .
    when the stock go up to 4 usd per share , and if the option go up to 10 usd ,what will happen??

    a friend tell me ,excess liquidity will <0 ,you will be sold some of your stock or option ,to make excess liquidity >0,because the rule in many brokers is:
    Equity with Loan Value 400000
    Cash Value 0
    Stock and Bond Value 400000
    Span Option Value 0

    Net Liquidation Value 400000
    Non Span Option Value -100000
    Reg T Equity with Loan Value 390000
    Initial Margin Requirement 400000
    Available Funds 0
    Maintenance Margin Requirement 400000
    Excess Liquidity -10000

    in this case ,brokers will sell some of your stocks or options to make excess liquitity >0

    if this is truth, the covered call is un--riskless!!
     
  2. MTE

    MTE

    Covered call is far from riskless. In fact, it has almost the same amount of risk as simply buying the stock. Your risk is that the stock goes to zero and you lose your 100,000 less the premium you received for the calls.

    If the stock goes up to 4 you don't get a margin call and your broker would not sell your shares. The risk in a covered call is strictly to the downside. And unless you buy the shares on margin you would never get a margin call.

    P.S. this thread/post belongs in the Options forum.
     
  3. rmorse

    rmorse ET Sponsor

    Covered calls are not risk less. It has a similar risk profile to shorting a naked put on the same line. The stock can go to zero and the option provide little protection, and caps your potential gain if the stock rises.

    You took a simple strategy made it very complicated. The purpose of using buy writes is to increase your overall return on a long portfolio with short term income. The negative, is that if you a great stock picker, your capping your returns with the premium over parity. If you would not buy the stock on it's own, the strategy in not appropriate.

    Bob
     
  4. These guys are right of course, major risk in covered write. If you inherited 10,000 shares of xyz, then sure, sell calls against it to generate some income.

    To go out and risk buying stock, just to sell calls against it is not really smart. If you're going to do that, consider just selling naked puts, same risk reward, and you're not paying $$, you're receiving $$ (always a better thing).

    And, don't read those stupid books about any type of synthetic, just no edge in doing that. Understand what a conversion is, and a reverse conversion, and realize that they all trade within a penny or two of fair value (interest and time decay).

    All the best,

    Don
     
  5. bc1

    bc1

    Congrats to the OP for figuring it out and making whatever point he was trying to make. Maybe you need a new choice of friends as I've never ever heard anyone say a covered call or anything involving the stock market was riskless.
     
  6. luofeiyu

    luofeiyu

    someone said:
    Using a much smaller hypothetical example, let¡¯s say an investor bought 100 shares of XYZ stock for $10.00 and sold 1 March12 10 strike call for $1.50. If the stock were to go to 0, the investor would lose the $1000 used to purchase the stock and collect the $150 from selling the call.

    i want to know what will happen when the stock go up sharply??


    when the stock go up,my option will lose money,if option price increase more than stock,
    maybe the excess liquidity <0
    the broker will sell some of my stock to make excess liquidity >0
    is it that the truth??
     
  7. MTE

    MTE

    The option price by definition cannot increase more than the stock price. So even if the stock goes to infinity you wouldn't get into a situation where a broker would liquidate part of your position. If the option goes far enough in-the-money then you would get assigned on your call, and your stock would just be called away (i.e. delivered against the option exercise).