Covered Calls are for SUCKERS… (Part TWO)

So, I know I ruffled a few feathers with that last title… so I decided to use it again!

😉

In the last post I showed how long call traders and market makers depend on the willingness of covered call sellers to take less when they win, and give up more when they lose.

No wonder covered call selling is the first thing most folks get exposed to in the world of options trading… for people in the know, it’s good to have more patsies at the table!

But you’re probably getting a little hot under the collar about options strategies you’ve been sold right now (No pun intended), so I’m going to illustrate another example that will make you take a second, very HARD look at covered calls and their kissing cousins.. naked puts.

Perhaps I’ll convince you that other alternatives deserve a second look as well. Shall we?

IN the last post there were three traders: the long call buyer, the covered call seller, and the market maker. All three were bullish on a stock and all three won some, lost some. But the covered call seller was the only one with a net loss.

THIS time I’ll show everyone getting a net loss… except for the guy that (wisely) buys INSURANCE when he picks up stock.

So our heroes are bulls. Auspicious Al needs no hedge; he knows how to time the market after all. Bullish Bob like to sell puts… the “parity” trade of a covered call. Which brings us to Conservative Calvin, who can’t bring himself to buy a stock without also picking up a put option to protect himself.

Here’s how these guys’ trades pan out:

Auspicious Al grabs 100 shares of XYZ at $100 a share. That’s $10,000 invested.

Bullish Bob sells the $100 put for $5. He takes in $500 but need to keep $10000 on hand to buy the stock in case he’s assigned: total of $9500 tied up.

Conservative Calvin picks up stock like Al, but also buys insurance: $100 per share PLUS $5 per share to protect himself. His is the highest invested amount: $10,500.

The stock goes up 20%!! Everyone makes money:

Al keeps $2000, when he sells. Based on the $10000 he put up, that’s 20%.

Bob received $500, but it was on a smaller outlay of $9500. Chalk up Bob for 5.26%.

Conservative Calvin gets a stock worth $120, and a put worth nothing. He makes a net 15%, not as impressive as Al of course… but more for the money than the guy that sold him the put!

Next play: say everything was the same… same time frame, outlook, etc. Only this time, something goes wrong. The stock is down 20%!

Assuming that Al does not reinvest his winnings and only uses $10000 of his 12,000 capital… he loses $2000. Back to square one.

(I should pause here and point out that if Al DID reinvest his winnings in 120 shares of a $100 stock that went down 20%… he would be in the hole, NOT back to square one)

Bullish Bob will have to pony up $100 bucks a share… $10,000 total… to pick up a stock that’s now worth $80. He will have received a little premium to do so, $500 from selling the put. That’s $9500 out for an asset now worth $8000. So his loss is not 20%, but 15.78%. Bob does better than Al this way, losing a lower dollar amount AND a lower percentage.

Too bad that Bob is now looking at a net loss though… 🙁 His $500 gain wasn’t enough to offset the $1500 loss so he could break even like Al.

Conservative Calvin, on the other hand, cashes in his put to sell the stock at $100 per share… he paid $105 per share for both the stock and the put, so he loses $5… or 5%.

Calvin makes $1500, then loses $500, for a $1,000 gain. In the SAME market that the other guys couldn’t make work for them. Hmmm…

Hey guys… see the point I’m looking to make? All six of these plays (one winning and one losing play for each trader) were bullish. All three made money on the way up, and all three lost money on the way down.

But in the end, only one trader ended up smelling like a rose: Conservative Calvin with a net gain, even when his win rate was only 50%.

Traders, think about it: we buy insurance for everything else, don’t we?

We buy insurance for our car.

We buy insurance for our house.

Insurance for our health… and if we have family, we buy insurance for our very LIFE.

But when it comes to the stock market we like to play it fast and loose.

Wow. Would you drive without insurance? Woudja own a home… yours, or an “income” rental property… without insurance? Of course not!

But when it comes to trading, everyone thinks they know the future. Their house couldn’t POSSIBLY burn down. You would NEVER get in a wreck…

Hmm. Or does it maybe make sense to take a second, very good look at what “hedging” is really supposed to do? IN the above example, the traders made money in good markets and lost it in bad. But the married put guy is the only one that KEPT enough of his winnings to matter.

When will this bull market end? I don’t know. More importantly, neither do YOU 😉 But one thing’s for certain: again, as before, I will be vindicated.

The “Champion of Married Puts” urges YOU to learn to hedge in your favor, NOT against. Who was clearly the patsy in the above game? Why, it was the Bullish Bob, the seller of puts. I was even generous enough to give him the spread… instead of selling for $4.90 I gave him the whole $5.00 that Conservative Calvin paid.

Okay Traders! You get the point. Again, the married put strategy is the best way to insulate your stock against losses. In the next post I’ll talk about how to use near-term plays to reduce your cost basis and BULLETPROOF a stock… but that’s for another day.

Didja “like” this post? LOVE it? Or am I your new favorite person to hate? Either way, sound off below. There’s only room for ten comments.

Happy Trading,

Kurt Frankenberg aka “The Champion of Married Puts”

About Kurt Frankenberg

Kurt Frankenberg is an author and speaker about entrepreneurship, martial arts, and trading the stock and options markets. One of several "Biznesses" he founded as a teen, The Freedom School of Martial Arts, has been in continuous operation since 1986. Kurt lives in Colorado Springs with his wife Sabrina, German Shepherd Jovi, and his ninja cat Tabi.