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Strategies & Market Trends : The Covered Calls for Dummies Thread -- Ignore unavailable to you. Want to Upgrade?

To: Road Walker who wrote (2184)	8/23/2001 12:02:04 AM
From: BDR	Read Replies (1) \| Respond to of 5205

<<I have a question about selling puts v. buy/writes, for anyone on the thread. A similar strategy, intended to collect premium. Obviously buy/writes require more cash than selling puts. But there are repair strategies with buy/write, if the underlying equity goes down, you can buy back the cheaper call and sell a lower strike. Assuming the stock doesn't go down more than ~5% a month, you can at least break even. If you sell puts, and the market goes against you, I can't visualize an effective repair strategy, other than assignment and then selling calls. Am I missing something?>> The analogous repair strategy would be to roll down the short Puts. The difference is that with CCs you have a net credit and with short Puts you have a net debit. The effect is the same though because with rolling down with CCs you are taking a loss you don't see. You have a bigger paper loss on the long equity position than you have a gain on the roll down of calls. With short Puts you have a cash loss with the roll down. The net value of the entire position should end up being the same, though you may be able to convince yourself you are better off picking up some extra premiums when you roll down the calls. Psychologically it is easier but financially the two should be the same. I think.

To: Road Walker who wrote (2184)	8/23/2001 1:10:52 AM
From: Dan Duchardt	Read Replies (2) \| Respond to of 5205

John, EDIT: OOPS!! I see I was scooped by Dale again. Hopefully this is a useful elaboration on what he already said. If you sell puts, and the market goes against you, I can't visualize an effective repair strategy, other than assignment and then selling calls. Am I missing something? A CC position in a falling stock will fall by an amount equal to the increase in value of a put at the same strike, neglecting the small effect of risk free interest. When you buy back a cheap call, it is cheap because you have lost value in the underlying stock. At that moment (before you write the call at a lower strike) you will have the same loss you would have from buying back the put at a price higher than where you sold it. Looking from that point forward, selling the lower strike call gives you a CC that is equivalent to selling another put at the same strike price as the new short call. It is harder to visualize, but for short puts the repair strategy is to buy back the old put, and sell a new one at a lower strike. Whatever cash you might have to come up with to make this exchange may be painful at the time, but rolling down to the lower strike put reduces your future cash commitment if you are eventually assigned. Think of it as making an installment payment on the stock you might eventually own. If you are not holding cash to back the short put, you will have to come up with some to make this payment, but in that case the short put is not equivalent to the CC to begin with. They are only equivalent if you have the short put backed by cash. When a CC position is just breaking even, a put will be losing time value at a rate that offsets the gain in intrinsic value. If you are fortunate to always be rolling down a short call without having your position value go below your net cost, then you could be buying back puts at the price you sold them, and then selling puts at a lower strike. It's easy to think you are getting a much bigger premium for rolling down calls, but in fact you are getting no more time premium from those calls than you would by selling puts. If you are selling ITM calls, you are largely removing your own money from the position, drastically limiting your forward upside potential or locking yourself into a loss while extending your downside protection. Selling the same strike puts similarly gives you very small upside potential (equal to the premium collected) while protecting you against assignment until that lower strike is hit. All this is theoretical of course, and exact equivalence assumes you are receiving the risk free interest rate for the cash backing the put. For a stock in steady decline, you may be able to capture better time premiums for puts than you can for calls. You certainly have a better chance of selling the puts at the ask than you would the calls. In that case you might very well do better selling puts. Dan