Jill, Profit/loss curves...how does that help me make a decision?
Draw an x-y graph. Plot option price on y, plot underlying price on x. At a given value for underlying (on x-axis), your option price (on y-axis) will have a specific value, changing over time as time premium erodes. If you draw such a graph for a covered call, and draw another such graph for a short put, you will see that they have the same curve; i.e., you make money/lose money on the option at corresponding prices for underlying. However, they are two different approaches. For example, you might already own the stock, and be a bit nervous about holding it "at these lofty levels". Therefore, you might pick an out-of-the-money strike (above current underlying price) that you decide you would be happy with; you sell a covered call and collect premium in exchange for capping your potential there. Conversely, you may not currently own the stock, but wish that you did. However, you are a bit nervouse about buying "at these lofty levels". Therefore, you sell an out-of-the-money put (below current underlying price), receiving a premium in exchange for agreeing to buy underlying if the price falls and you are put. You take on the risk of having to pay for underlying at that price, which reduces cash/margin availability in your acct. If stock goes up, your put expires worthless, but your opportunity cost is that if it goes up a lot (as qcom has, from 190 to 380 in a few weeks), you only collect the put premium even though you had taken on the risk of being put. So you "miss out" on a lot of upside. Likewise for covered calls. The price points for underlying where these strategies do well will follow the same curves, but people might have different reasons for using one approach or the other. For further information, it is best to consult "McMillan On Options" or some other option books. It is a good idea to have familiarity with these strategies before using them, and understanding the profit/loss curves is the starting point.
My advice: Read a book on options before you trade them. |
