Why is selling a covered call identical to selling a put?

Discussion in 'Options' started by ghankins, Aug 9, 2005.

  1. ghankins


    I'm reading a book on options trading and when I got to the section on covered calls I remebered this excerpt from "The New Market
    Wizards" p. 384.

    Could someone please explain why selling a covered call is identical to selling a put. I cannot figure this out.

    "The New Market
    Wizards" p. 384:

    Q: Covered calls [buying a stock and selling a call against it] are
    frequently promoted as trading strategies. As we both know, doing a covered
    call is identical to selling a put. Is there ever any strategic rationale
    for implementing a covered call instead of a short put, or is the former
    promoted because it involves a double commission, or perhaps for semantic
    reasons- that is, even though the two trades are identical, the covered
    call sounds like a less risky proposition than a short put position?

    A: I don't know how to articulate the fraud that is sometimes perpetrated
    on the public. A lot of strategies promoted by brokers do not serve the
    interest of their clients at all. I almost feel guilty when taking the
    other side of a covered call position, because it's obvious that the
    customer is operating under a misconception.

    Q: Then you agree that anyone who wants to do a covered call would be
    better off simply selling a put, assuming that he plans to initiate and
    liquidate the stock and call positions simultaneously?

    A: Right. If you want to guarantee an inferior strategy, do covered calls.

  2. because if the stock goes to 0 both have the same risk of loss.
  3. TGregg


    There's an awesome way to understand all these simple option strategies. Plot the profit curve based on the exiting price. If that's too complex, plot the curve for each instrument based on the exit price, then add them up.
  4. Put it this way: buying a call is the equivalent of buying 100 shares of stock and buying a put to protect those shares (unlimited profit potential, but loss is capped at cost of the call).

    Selling a call, conversely, is equivalent to selling 100 shares of stock and selling a put. If one sells a call naked, and the stock price goes down, the gain is limited to the premium that was written. Likewise, if one sells a naked put, and the price of the stock goes up, the gain is limited to the premium written.

    If you do a covered call by buying 100 shares of stock and selling a call, here's what you're doing:

    buying 100 shares of stock=long 100 shares of stock

    selling a call=short 100 shares + selling a put

    100 shares minus 100 shares is zero.

    You're left with the short put.

    IMO, selling a put is makes more sense than covered calls. One less transaction.
  5. While not disagreeing with the general sentiment of the wizards, I don't think this is exactly true. The put seller is long cash relative to the cc seller.
  6. Or a simple example.

    The stock is trading at 90. The 100 call with 1 month left is trading for $0.48.

    You decide to buy 100 shares for $9000 and sell the call for $48. Your entry to the covered call cost you $8952, net debit.

    Lets look at what happens if you hold the position to expiration for various strikes. K = Strike

    K Position Val At Expiration P&L
    50 (50*100) = 5000 -$3952
    70 (70*100) = 7000 -$1952
    90 (90*100) = 9000 0
    100 (100*100) = 10000 $1048
    110 (100*100) = 10000 $1048

    Whats another option position that has unlimited risk if the price drops and limited reward on the upside ? Selling a put !

    In the case of selling a put, you collect a premium for selling it, and that premium erodes as the price of the stock declines past the options strike.

    I agree with TGregg. Most option strategies will become crystal clear if you plot the various outcomes in excel.

    Just think in terms of what the position costs to get into it, and the value of the position at expiration at different strikes. P&L is the sum of those two values.

  7. Not quite. Synthetically, a buy/write call is equiv to writing a put, just like sell/write put is equiv to writing a call.

    The differences between the strategies, assuming equal premium, are in (1) margin required (selling a put requires much less margin): and (2) transaction costs. Selling a put is a smarter move generally becaue you are dealing with at least one less commission and at least one less bid-ask spread.

    The option buyer is actually the borrower; the writer is the lender.
  8. MTE


    It's called Put-Call Parity.
  9. What happens if your stock goes down? Lets say u bot stk at 100 and wrote call at 2, if stock goes down below 98 you are losing pt for pt. now lets say stk is 100 and you just wrote a put for 2, if stock goes below 98 same thing.
  10. ktm


    I think part of the issue may be the intended audience. Most of the trading public doesn't deal in options. Many may not have the right or ability to write uncovered options in their accounts. Since owning stock is so basic, it is easier to explain the covered call concept to people. I would imagine no one wants to be deemed responsible for a blowup for showing them how to sell premium. They get carried away and forget that they need to be able to buy the stock when assigned and then get in trouble.

    Sure it's mathematically the same, but look at public perception. People are more receptive of a stock going to zero than "losing all your money in options". Yet another industry that quickly separates the uninformed from their cash.
    #10     Aug 10, 2005