32 lines
2.0 KiB
Plaintext
32 lines
2.0 KiB
Plaintext
Covered Call
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The problem with selling a naked call is that it has unlimited exposure to
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upside risk. Because of this, many traders simply avoid trading naked calls.
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A more common, and some would argue safer, method of selling calls is to
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sell them covered.
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A covered call is when calls are sold and stock is purchased on a share-
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for-share basis to cover the unlimited upside risk of the call. For each call
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that is sold, 100 shares of the underlying security are bought. Because of the
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addition of stock to this strategy, covered calls are traded with a different
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motivation than naked calls.
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There are clearly many similarities between these two strategies. The
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main goal for both is to harvest the premium of the call. The theta for the
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call is the same with or without the stock component. The gamma and vega
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for the two strategies are the same as well. The only difference is the stock.
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When stock is added to an option position, the net delta of the position is
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the only thing affected. Stock has a delta of one, and all its other greeks are
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zero.
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The pivotal point for both positions is the strike price. That’s the point the
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trader wants the stock to be above or below at expiration. With the naked
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call, the maximum payout is reaped if the stock is below the strike at
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expiration, and there is unlimited risk above the strike. With the covered
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call, the maximum payout is reaped if the stock is above the strike at
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expiration. If the stock is below the strike at expiration, the risk is
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substantial—the stock can potentially go to zero.
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Putting It on
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There are a few important considerations with the covered call, both when
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putting on, or entering, the position and when taking off, or exiting, the
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trade. The risk/reward implications of implied volatility are important in the
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trade-planning process. Do I want to get paid more to assume more
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potential risk? More speculative traders like the higher premiums. More
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conservative (investment-oriented) covered-call sellers like the low implied
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risk of low-IV calls. Ultimately, a main focus of a covered call is the option |