The 6-Week Options Trading Kickstarter: Covered Calls
Steve Smith breaks down a popular options strategy.
Brokers love to promote covered calls as a relatively conservative strategy, and investors who claim they would never sell naked options (meaning being short an option with no offsetting stock position) are all too willing to buy into that notion. But the reality is that the risk/reward of a covered call is no different than selling a comparable put short.
Let’s go back to IBM. The September at-the-money (or ATM) $200 call can be sold for $4. This would give you a downside breakeven point of $196, which is calculated as the stock purchase price minus the premium sold ($200 - $4= $196) and would have a maximum profit of $4 for an effective sale price of $204. That is the strike price plus the premium sold ($200 + $4 =204).
By comparison, the $200 put can be sold for $4.90, which means your effective purchase price if you were assigned the stock would be $195.10, which is the strike price minus the premium collected ($200 - $4.90 = $195.10) while the maximum profit is $4.90, which is the amount of premium collected.
However, when we account for dividends, the risk/reward of a covered call and naked short put is exactly the same. Adding the $0.90 to the $4 equals $4.90 -- the same amount.
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