Yeah, I mostly agree. It makes sense writing calls on a stock you expect not to move up or down dramatically (cause if it goes up a lot, you'd much rather own the stock, and if it goes down, you lose.)
It's possible show that selling a covered call is equivalent to selling a put. Suppose that you had a $25 stock that has options with a strike of 25. Suppose you're long the stock, and sell a 25 call, and buy a 25 put. You don't have any risk on this transaction, since you can exercise your put if the stock goes down. But calls usually are more expensive than puts, so this appears to be a risk-free way to make money.
Except that to buy the stock, you're spending money that would otherwise get interest. The interest it would have generated will be equal to the difference in the premiums. (Dividends also need to be taken into account, of course.)
For me, this is a convincing argument that, if you're long a stock and short a call and long a put at the same strike, then you're actually neutral. It's convincing because if it weren't true, then you would be able to generate risk-free interest at above the risk-free interest rate. (Either by going long stock, long put, short call, or by going short stock, short put, long call.)
So, if long stock + short call + long put is neutral, it means that short call + long put is the equivalent of short stock. So then,
short call + long put = short stock
But when you flip this equation around mathematically, you get:
short call + long stock = short put.
So, a covered call is equivalent to a short put.
(It also means that, in a market that's way above any historical valuation ever, many of the people here are making money by shorting puts. What fun! :) I usually skip the covered call part though, and just sell a cash-secured put, and only do it with stocks that I believe are way undervalued.)
Richard |
