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Can someone please help me in figuring out what would be the strategy to implement, if I am wanting to do a covered call , but am Bearish on the trade ?
I would just buy the stock and sell a Put correct ?
And to replace the stock with an option, then I would look to place a BearPut spread ?
Just want to make sure that I understand correctly, the right strategy to mimic the covered call, but doing it when I am Bearish on the trade, and am expecting the trade to drop in price .
I was reading through some of my older books on spreads, and all that is mentioned is being Bullish and selling covered calls on stocks you own, when you and Bullish and expect the stock to go up.
But there are plenty of times when I see a great setup , and am Bearish and expecting the stock to drop in price, so I want to be able to replicate the opposite od a covered call... I.E. a " covered put "
Thanks for the help - Michael
Can you help answer these questions from other members on NexusFi?
With a covered call your downside is the loss that you make with the underlying (not protected). Your upside is limited to the difference between the market price and the strike price of the short option. As a compensation you receive the premium that you collect when you write the call. A covered call is a moderately bullish position. A covered call also makes you money, when the underlying moves sidewards, as you have collected the premium. Furthermore, the covered call is equivalent to a short put, which has the same payout profile. You collect the premium, but you lose money when the price of the underlying declines.
If you are moderately bearish on a stock you could (both strategies are equivalent)
short the stock and sell an out of the money put (not very practical)
or simply sell an out of the money call
In both cases you will be able to collect premium, but lose money when the price of the underlying moves up beyond the strike price of the option.
Replacing the stock with an option
You can limit your risk by adding a long put option at a lower strike to your position. The put is called the floor and the resulting strategy is called a collar.
long stock + short call (strike above the money) + long put (strike below the money) = collar
With a collar you use the premium collected from the short call to pay for the premium for the long put. If we remember that the long stock + short call position is equivalent to a short put at a strike above the money, we can build the same position as
short put (strike above the money) + long put (strike below the money) = bull put spread
So we have come to the conclusion that you can replace a collar with a bull put spread, as both of them have the same payout profile. The main difference is that the bull put spread is a credit spread while you need to pay for the stock in the case of a collar. The bull put spread collects premium. The maximum gain is achieved at or above the strike of the short put which would then expire worthless.
Hi Fat Tails,
Thank you for taking the time out to explain in as great of detail as you did, the comparisons of different strategies that have the same profiles, as that of a CoveredCall ( Bullish ) and a Collar / BearCall if ( Bearish )
I guess the problem in being Bearish the position and selling a Call, is that by being " naked ' the call, the Margin requirement will be quite high, compared to doing a BearCall or BearPut spread.... more credit received by selling the call Naked, but much more margin required than doing one of the spreads
Do you find there to be any advantage to doing a Collar vs a CoveredCall and just putting in a hard stop Loss on the trade ?
Or maybe even doing a Married Put vs a collar or placing a hard stop on the trade ?
Thank you again for sharing and explaining the breakdown of these various strategies
Selling a call is no more risky than shorting the stock. In both cases the position will suffer, if there is a takeover announcement that double the share price. Theoretically the risk is unlimited, as the share price can move up to a multiple of the current price. I would probably not engage in such a strategy without seeking protection by buying a call at a higher strike price (bear call spread).
Unlike selling a naked call, selling a covered call has a limited risk, which is already paid for as the underlying was purchased. A collar would give you further protection to the downside, but it comes at a price, as you have to pay the premium for the long put.
In the end it all depends on your view of the market and your risk appetite.
Thank you for your replies and help with my questions regarding CoveredCalls and it's Bearish equivalent
Of course nothing works perfect , and we could get stopped out r....
on the upside, could get called out / make a profit on getting called away from the stock and make an extra profit via the difference of the price at which the stock was purchased and the strike of the call that we sold.
Also, at times, we may even be able to sell 2 calls within the same month and collect 2 premiums , maybe
I definitely think the CoveredCall strategy is powerful and can work.
My comments/questions come down to....
1. I suspect that putting in a hard stop on each stock / trade s imperative, as getting stopped out is always a possibility, although the credit received from selling the call does help offset this
2. To sell with 1 month or less till expiration for any decent credit on lower priced stocks ( $3 - $10 ) , then the stocks themselves will have to have high Implied Volatility, just to receive a decent premium for the AT to just slightly OTM strikes
3. I would say that to have an extra edge with this strategy, that the stock we decide to buy, that it needs to look like it is poised for an Upward move/ breakout ( based on the chart(s) ), as well as the stock having a Beta of over 1 and or Implied Volatility of 50% +
( and an IV rank ) of above 50% ( TorS platform indicator )
4. What strategy do we use, to replicate a CoveredCall, but to do this when we're Bearish on a stock and think it will go down in price?
Would we simply just buy the stock and sell a put ?
5. And lastly please.... If you have a very Strong directional bias on a trade, say... Bullish , what would be the 2 main strategies that you would look to initiate?
Thanks so much to anyone who cares to shed some light and contribute
1. If you set a stop it isn't just possible....it's probable that you will be stopped out. If your platform doesn't support OTM/ITM then just look at the Deltas of the strike you would want to be stopped out at. A strike at the .70 Delta has about a 30% chance of expiring ITM....but the chance of it being tested before expiration is almost double that...see Probability of Touch.
2. Yes...high Implied Volatility helps....but on these cheap stocks with high implied volatility rank be prepared for one of them to lose 50% on a over night gap down (no stop will help you here) as whatever was creating the volatility comes out and is priced in....then volatility contracts significantly, open interest erodes and you have a hell of a time selling calls for months on end trying to get back to even. Sticking to high quality , highly liquid stocks with deep open interest and volume will help to avoid this scenario.
3. Ye...when I look for a covered call I look for liquidity first, beat down to a perceived price extreme with a higher IV Rank. If your account permits you might take a look at selling a naked put instead sometimes. The risk profile is pretty much the same but the capital requirements are sometimes less than doing a covered call....therefore a better return on capital and you can go to a higher probability strike.
4. The opposite of a covered call is a covered put (sell the stock and sell a put) but there may be a big difference in capital requirements. If you are bearish it may be better to just sell a call OTM then buy a call further OTM to reduce capital requirements....if you make it really wide like 5-10$ the risk profile starts to look like a naked short call but requires much less capital. (the risk or capital requirement on selling a spread is equal to the width of the spread minus the credit received)
5. Sell a put or put spread....but only if liquidity and IV Rank allow.
I appreciate this post if quite a few years old but its super interesting.
Just to summarise:
> covered call: long futures and short call (limited upside, and unlimited risk)
> collar (covered call with using a portion a of the credit collected from the short call to by a put): limits risk
> bull put spread: which has the same payoff profile as the collar, but using 2 puts only. Defined as:
"short put (strike above the money) + long put (strike below the money) = bull put spread"
I am keen on making sure i understood this.
When i think of a short put spread... i think of 2 Out-The-Money options (both strikes are below the market).
Am i correct in saying that the definition above refers to selling an ITM put... and buying an OTM put?
have i understood correctly ?
If you are really interested in the subject, you should go for one of the books that deals with options trading. My favourite is the book "Options as a Strategic Investment" by Lawrence G. McMillan. The book is an easy read, as it is mostly descriptive and does not make use of advanced mathematics.
