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Minyan Mailbag



Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.

Professor Succo,

Today on the Buzz & Banter, Toddo wrote that a "buy-write" has the exact same risk profile as a naked short put (defined reward and risk to zero). Why would you ever do the covered call and tie up funds when you could get the same risk profile without tying up nearly as much money by doing the naked put write?


A portfolio manager executing a buy-write (buying stock and selling call at the same time) has the exact same risk profile as if she would have sold a naked put. Under Regulation T, an at-the-money put requires the seller to post 20% of the strike price with their clearing firm as collateral. When doing the buy-write, the stock is normally paid for in full (although 50% margin can be posted) less the premium received from the covered call. So why wouldn't the portfolio manager sell the put since less money is required?

First of all most "buy-writers" are funds that don't use leverage. Their charters therefore prohibit them from selling "naked" puts as being a risky strategy. It makes no sense and illustrates a lack of understanding that a charter would allow a buy-write but not a short put. The portfolio manager, however justified (a buy-write is a little less risky than owning a stock), is violating the spirit of the charter by doing a buy-write.

Secondly, buy-writes are little used these days. Most call selling is done by managers that are already long the stock. After the stock rises and gets close to a targeted exit point, a manager will often sell calls as part of an exit strategy. This makes perfect sense.

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