For anyone interested in covered call selling, consider understanding naked put selling as a better option. The risk/reward graph of both methods will show writing naked put options is the same as writing covered call options. (selling = writing, for those not familiar with the term.) They both pay you up front to limit your upside return while leaving you open to big losses if the stock goes to $0.00. I'll admit when assigned a stock after selling a naked put I write covered calls sometimes, but my greatest returns come from writing naked puts. Here are the five of the reasons why:
- The best covered calls' profits come from volatile stocks. Writing options in the money (ITM) will reduce this risk, but with covered call options you will face the wash rule when a stock is assigned and you re-write the covered call option at a the same strike (i.e. less than your purchase price). This is more common when you write deep in the money covered calls. Writing naked puts lets you buy the stock at the reduced price so you are able to sell covered call options after being assigned the stock at the same strike, therefore dodging the wash rule, legally.
- Covered call income is less than naked put income since you do not have to own the underlying stock with naked puts more 「margin-free」 cash can be used for naked puts. This creates greater cash flow. Warning: selling more naked puts than you can afford to be assigned is a recipe for disaster. I attempt to write naked puts on two times the cash I have in reserves. In a hard fast fall I stand to loose a large percentage, but in the other 119 months in between such events I do very well (assuming an event like this happens every 10 years).
- Covered call investing requires you to own the underlying stock. Naked put investing allows you to keep your cash in a money market gaining interest while the time value of the options' premiums deteriorate.
- Selling covered calls with leaps keeps your cash tied up even longer. Selling naked puts with leaps lets you gain even more guaranteed interest in your money market while the naked put option deteriorates. I prefer selling options with shorter time horizons, but it's worth mentioning since some others prefer the longer holding periods.
- Selling covered calls takes two trades to enter a position while selling naked puts only takes one trade. Commissions are saved by selling naked puts.
- Selling covered calls gives you two opportunities to miss the best price to enter the position while selling naked puts allows you to be more patient with your entry points by using only one limit order. If y