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Minyan Mailbag: Hidden Risks in Funds

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Please be careful---and for sure, know what you own...

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Toddo,

I really like web sites like Minyanville, thanks. Calm, easy, experienced people writing on investment.

I followed your posts on
www.realmoney.com. They were very helpful following 2001.

I also have a question. I'm not sure I understand why long stock, short calls has the same exposure as naked short puts.

To me long stock short calls is selling covered calls. But I think you are referring to shorting index calls against a basket of stocks.

Selling covered calls is something I stopped after 2000-2001, but I would never consider selling naked puts.

I ask because I own a fund that does this income buy write in my 401K. So I just want to make sure I understand this risk

Thanks again for sharing your knowledge on Minyanville. I have already started telling friends about the site.

Minyan John


Thanks for the snaps, Minyan John. Much obliged.

Be sure to read Professor John Succo's derivative tutorial as he's the sharpest risk manager I've ever met. He scribed this many years ago on the 'Ville and my sense is that alotta folks would benefit from the review.

Your question is timely and pertinent. If you own an "income fund" that owns stocks and shorts calls (buy-writes), you are indeed naked short a synthetic put. Think about it, your percentage gain is capped to the upside (the premium of the call) and you've got big downside (stock price minus the premium). This is exactly the same risk profile as a short put (defined gains if the stock rallies, open downside if it fails).

Now, buy-writes "in here" (with the VXO near 30) could work, I suppose, but the risk is still the same. My thought (fear), however, is that "income funds" piled on and sold calls when the VXO was 10-12, which is part of the reason for the increased volatility.

Please be careful---and fer sure, know what you own my brother.

-Toddo

R.P.
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