I know these positions are "essentially" or "almost" identical, at least that is what I often read. So, why the qualifier? Is the risk, theoretically, higher on the short put because of the volatility component, which could -- if there was a gigantic spike -- make the price (or loss) greater than the loss on a covered call with the same strike, etc. In other words, the short put has a theoretically unlimited loss potential, because of the vol., whereas the CC loss is clearly defined.
So the price of put cannot spike higher than the maximum loss of an indentical covered call? (Except in the interest rate scenario you describe.) What about Oct. 87, when the Vix hit 240 or something?
One major qualifier: Ideally, the CC trade will hold equal numbers of short puts and covered calls. That is, if the position is a large portion of the portfolio. A CC[short put] is preferred in a falling[rising] short-term rate environment due to changes in the implied-forward. Rho-risk should exceed microstructure considerations.
Lets say underlying is @ 10. I sell a call for 1. Stock goes to zero. My downside is 9. Ok, now let's redo. I sell a put for 1 naked. Stick goes to zero from 10. I keep my 1 premium. And my put is ITM 10 pts. -- but may have a volatility of who knows what, increasing the price, right? Or not?
It would be shown that a print of 200-vol would represent a condition in which short-term rates would be dropping rapidly. It would make sense to be holding CCs, but the offset would involve a large loss of edge on the stock execution. I would assume the gain from rho would exceed the edge-loss from the stock cover.
1) For contracts whose lowest price is zero; i.e. stocks, bonds, grains, metals, energy, the maximum risk of a short-put is "Strike Price minus premium", a finite number, not an unlimited number. 2) Short-term interest rate contracts indexed to 100: i.e eurodollars, the maximum risk of a short-put is potentially infinite. The contract price can go below zero. If short-term interest rates went from 3% to 1000%, the futures would go from +97.00 DOWN to -900.00. 3) In the days after the "Crash of 1987", all options sky-rocketed in value. It was most obvious in the out-of-the-money strike prices. From that point forward, volatility skews "smiled" instead of "smirked". 4) The short-put can be slightly less risky if it's initiated out-of-the-money and offset before it gets in-the-money. That way, it may have better liquidity at-the-money before it goes against you too far. 5) I took too long to compose this. 5 additional posts came in while I put this together. :eek:
Thanks for the affirmation. I guess my fears are irrational, or left from '87 or from reading about Neiderhoffer. I do mainly ES, NQ, ER2 and selling naked puts to me just seems so much more risky that a covered call. Irrational, I guess.
Try to do put-selling after huge downdays when you'll collect higher premiums, not when the market is making near-term highs.