What is the risk in selling a covered call at
a strike price considerably higher than the stock price at the time I wrote
the call?
Whenever you write a covered call, you first have to decide that you would be
happy to lose the stock at the net effective sale price (NESP= call strike
price plus call premium). If NESP does not provide you with the profit you
anticipated when you first acquired the stock, you probably should not write
the call. Keep in mind that writing a deep out-of-the-money call (or, as you
stated, "a…call at a strike price considerably higher than the stock price")
may offer very little premium. You will want to ask yourself if the net
premium, after the transaction costs, is enough to justify the transaction.
There is a rule of thumb often employed by many covered call writers: the
potential return, if the stock is called, should be about twice the risk-free
(Treasury bill) rate. As an example, if a 60-day Treasury yields 5% per annum,
a two-month covered call write should produce an annualized 10% return.
A corollary is that the return engendered by the covered write should at least
equal the risk-rate if the stock remains static. Another guideline regarding
premium is that the downside protection gained by call writing should at least
equal 3% of the stock's current market price.
I sold a naked call and then bought the same
call. Is my naked call now covered?
Generally, if someone purchases the same call that was sold, it's likely that
the two transactions would be matched as opening and closing transactions and
the position would be eliminated. While not common, there may be some
strategies where an investor wishes to remain long and short on the same
contract. If this is the case, the naked margin requirement would be
eliminated, but the position still bears the risk assignment on the short call
option.
Can I perform a spread by purchasing an at the
money LEAPS call , and selling a front month out of the money call?
Yes, the strategy you described is also known as a "diagonal call spread."
When considering implementing this strategy, you should be aware of the risks
associated with the strategy, along with the (potential) rewards. In the worst
case scenario, should you be assigned on the front month call and then
exercise your LEAPS to cover the assignment, your loss would be the net debit
paid to establish the position less the difference between the strike prices
of the two options.
It’s more difficult to establish a maximum gain for this strategy, which in
many ways resembles the Covered Call. The best case scenario is for the stock
to go sideways or gradually rise over the life of the LEAPS call, thus
allowing you to roll out your front-month option every month at a credit.
Review the various LEAPS strategies, including spreads in the
LEAPS section of
The Option Industry Council's (OIC) Learning Center.
What is the difference between a Call and a
Put - and why can't I sell a Put when I'm long the stock?
An equity option is a contract. The call contract conveys to its holder the
right, but not the obligation, to buy shares of the underlying security at a
specified price (the strike price) on or before a given date (expiration day).
The put contract conveys to its holder the right, but not the obligation, to
sell shares of the underlying security at the strike price on or before a
given date (expiration day). After this given expiration date, the option
contract ceases to exist. If assigned, the seller of an option is, in turn,
obligated to sell (in the case a call) or buy (in the case of a put) the
shares to (or from) the buyer of the option at the specified price.
In the case of a covered call, the investor sells a call option contract while
at the same time owning an equivalent number of shares of the underlying
stock. If an investor is assigned an exercise notice on the written contract
he/she sells an equivalent number of shares at the call's strike price.
As for why your broker might have concerns about selling a put option while
long the underlying stock, if the investor is assigned an exercise notice on
the written contract he/she buys an equivalent number of shares at the put's
strike price, effectively getting "longer" the underlying stock. For more
strategy related questions, visit the
Strategy section
of The Option Industry Council's (OIC) Learning Center.
I understand that there are discrepancies
in options pricing between puts and calls and among the different expirations.
How should I take advantage of this situation? For how long do these
discrepancies exist, and where can I learn more about them?
It would be more appropriate to say that there are different levels of
volatility and costs of carry for puts and calls and for different strikes and
expirations. But this complexity is not artificial, it reflects actual
differences in the factors that influence an options' price. For example, most
options pricing modes are based on the Normal Distribution Function -- but
stocks tend to deviate slightly from the Normal model, and traders compensate
by tweaking the volatilities (skew) that they input into their model. In the
case of puts and calls, the cost of carry tends to push calls to a premium and
puts to a discount -- but the early-exercise feature prevents puts from
falling below their intrinsic value, which distorts the put-call parity that
would exist for European-style options.
Traders can and do take positions that benefit from changes in cost of carry,
volatility skew, etc. But it's very difficult to calibrate such positions, and
it generally requires making quite a few trades. So these types of strategies
are usually only suitable for full-time investors who have very low marginal
trading costs (although they often have high fixed costs, such as exchange
memberships).
An excellent first read on the subject,
this book carefully and completely defines the terminology, explains options
investing step by step, and presents strategies so that it is easy to understand
at each level of risk involved.
Spend less than you earn! People who spend every penny
they make usually end up going broke.......
Take enough risk on the money you save! Playing safe by
putting your money under the mattress or in a savings account
will not make you wealthy..
Remember that.....Fully one-fifth of humanity, some 1.3 billion people,
struggles to survive on less than $1 per day. About 40% of
humanity survives on less than $2 per day. More than a billion
people around the world will go to bed hungry tonight. Life
expectancy in some 32 countries is less than 40 years. If you
have a few extra dollars in your pocket (you don't have to be a
millionaire to make a difference), please share some of your
financial good fortune with others who are in great need.
Think About It... Being in the 'now' brings a freedom, unlike living
in the past or in the future, which is a kind of imprisonment.
This isn't a kind of a denial where you pretend life doesn't have
problems. Life is full of problems, but most of those stresses
and failures are reliving old hurts or worrying about future
concerns. -- Carl Honore
When you 're diagnosed with cancer, you start to
bargain with God: "Let me get through this, and I'll take better
care of myself. I'll get my priorities in order. I'll learn to
live every day to the fullest." Isn't it sad that you have to get
sick before giving yourself permission to live life to the
fullest? -- Robert Schimmel
Look at Life in different & Positive ways
