Covered Calls

[Effkay]

I was looking into covered calls, and was wondering if there was a way of protecting my losses 100% to the downside, apparently it can be done (so I've heard!)

Also if you were to do a covered call for a covered call sake, is it just a balancing act between risk/reward when choosing itm or otm calls?

The way I see it is that an ITM covered call gives you lower reward and lower risk, as you have more downside protection? Does anyone disagree?

Thanks

 

[RogerM]

Effkay - if there is a way to cover losses 100% then it will also limit profits to zero as well. Taking on risk is what we are are paid for. There are no free lunches. What options do particularly well is to enable you to construct a position with just the amount of risk you are prepared to accept, provided that you are prepared for the lower potential profit that low risk implies.

 

[Effkay]

I guessed so....but I've heard it's possible....I'm not too sure how...but there you go....

Surely ITM covered calls give you lower risk?

 

[Profitaker]

Effkay

Yes, you can protect 100% against downside risk, but only at the expense of profit potential. You cannot make a profit unless you take on risk, whether it be directional risk or volatility risk – simple as that. Anyone that tells you otherwise is badly misinformed and destined to lose their shirt, IMHO.

As far as covered calls go, it’s not a strategy I’d entertain. The reason being that you could achieve the same P & L profile by shorting a naked Put. Why pay 2 commissions when you need only pay one ? If you already hold the stock for the long run and are looking to enhance returns then covered calls work fairly well. Anyway, back to answer your questions…

is it just a balancing act between risk/reward when choosing itm or otm calls?

Yes. When you sell calls against long stock you’re selling off the upside potential in the stock, whilst retaining full downside risk. How much upside you sell depends on which strike you choose – the further OTM calls you sell the more upside you get to keep, but less downside protection (less premium). The nearer to ATM calls you sell the less upside you keep, but you have more downside protection (more premium). So yes, a balancing act is a good description.

Always look at the time value in the call options you’re considering selling – not the intrinsic. TV is what you are selling and are aiming to keep. Maximum time value is found in ATM options. However, it is a balancing act as you say.

P.S. I urge you to look at naked Put writing as a better alternative to Covered Call writing.

P.P.S. I’m a novice too - nothing wrong with that !

 

[parisd]

Hi Profitaker and Ekffay

Just a question; naked put writing and covered calls are same, but option trading level for covered call is 1 when trading level for naked put is 4 (at e-trade USA) and I was told no US broker will let you to short puts if you dont have at least 100K in your account (not verified). Is it same in the UK ?

I have covered call trading authorisation not more for themoment.

 

[Profitaker]

parisd

Don't know about the US as I only trade the UK, but it's not like that here. There are margin requirements, but it's quite a scientific calculation, rather than an arbitrary ($ 100k) figure needed. No problem writing naked here - you just need to have the margin (cash) in place, and if the position moves against you then you get "called" (stump up more cash or close).

Sorry I can't be more help, but the US market isn't my forte.

Hopefully others will know the answers.

 

[Effkay]

This question is about covered call deltas

If I do at ATM CC, what is my delta position? Surely there is no upside potential? I calculate delta as +50, can anyone help me with this? Or is it that +50 means that as my position falls I will lose?

 

[anley]

Eff

RogerM hit it right on the head, you get paid to take on risk in this game. If you want no risk then you'll have to accept no profit potential as well. Forget about what you've heard it;'s most probably from someone who read a 500 word article in the Investors Chronicle or something like that.

If you want to trade options then remember that the odds are against you because on the other side of the trade are some of the best and most brilliant minds in the markets and if they don't get you then the bid-offer spread likely will.

Also right now in my opinion CC are a bad trade for many stocks because volatility is at very low levels indeed. I'd also prefer to sell puts shorts, it's a cheaper trade to do and as Paris pointed out.

Go download Hoadley Options and you'll soon see how all the different strategies perform.

 

[Effkay]

I've got that mate, I was just wondering about deltas as it was raised on another thread, didn't understand it on hoadley

 

[parisd]

Effkay,

To answer your yesterday post, the stock has always a delta of 1,00 and the ATM call has a delta of 0,50. This means for the stock dropping 1$ your Call value drop 0,50$, but I should say for the stock dropping 0,1$ your Call value drop 0,05$ because as soon as the Call goes ITM its delta increases

Deep ITM call has delta close to 1 and well OTM call have a delta much smaller than 0,5.

If stock does not move the call value drops slowly because of its time value (Theta) especially for thecloser month expiration.

 

[greenfuji]

In Australia a Covered call trade consists of one short call and 1000 long shares. In America the same trade consists of one short call and 100 long shares.

How many long shares are required to short one call in a covered call trade on the London Stock Exchange?

Also, are the options on stocks on the LSE American style or European style, that is can they be executed prior to expiry or only on expiry?

 

[Robertral]

In Australia a Covered call trade consists of one short call and 1000 long shares. In America the same trade consists of one short call and 100 long shares.

How many long shares are required to short one call in a covered call trade on the London Stock Exchange?

Also, are the options on stocks on the LSE American style or European style, that is can they be executed prior to expiry or only on expiry?

UK one contract is 1000 shares and the UK equity optiosn are American style, and the FTSE index options are European

PS watch out for AZN options are the contract size changes for quartly options