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mango

Selling Naked Calls and then Potentially Buying Underlying Stock Later

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Hi all,

 

I've been trading stocks for a couple years now but have only dabbled in some basic options trades (i.e., buying calls/puts). Anyways, I've been messing around with options more lately and recently came across a scenario in which I need some help.

 

Let's say you write an out of the money call with an expiration 1 year away. 6 months later, the stock is right at the the exercise. I realize you could close out the position by "buying to close", but this could be potentially expensive given the remaining time premium and the fact that the underlying share price is close to the strike. What if you just bought the underlying stock at or near the exercise price (assuming you had enough money to buy the underlying stock). Then, 6 months go by and the stock has gone up and the option is exercised. The losses on the call option is then cancelled out by the appreciation of the underlying stock you just bought, though you still have the premium. Assuming you can buy/sell the underlying stock as it moves around the exercise price, seems like you can always protect yourself against a loss (not including fees).

 

What am I missing? At best, the stock moves down and you pocket the premium. At worst, this seems like a way to generate yield (proceeds from writing the option / total cost of owning the stock).

 

Here's an example of how I'm thinking about this. Netflix Jan 2015 $450 call is selling for about $20. You sell 1 contract. If stock moves to $450 in 3 months, you buy 100 shares of nflx stock for $45,000. Jan 2015 comes around and nflx is at $500. At exercise, you have to sell 100 nflx shares at $450, so you receive $45k and then hand over your shares (which you bought for $45k). This would imply 4.4% yield (8.8% annualized, before fees).

 

This can't be a way to get some pretty good yield risk free, can it? Seems like I'm missing something very obvious.

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Some thoughts:

 

"On paper" - things look much cleaner than in execution - which is part of the basis of the "whipsaw comment" in one of the replies.

 

Selling naked calls a potentially unlimited liability. The moment you purchase the underlying the position becomes "covered".

 

If you own positions and want to protect - you can buy out of the money puts to protect the downside.

 

If you believe the positions may go up - but only to a certain point you can sell a call just above. (The call is covered because you own the position.) If the position does not reach that call strike price by the date then you keep the premium and the position. This can be done over and over in markets that smoothly rise.

 

In rising markets the following strategy is more difficult.

In choppy markets it works pretty well.

in falling markets - you have to be careful not to exceed your ability to buy what is "put" to you.

 

Selling puts, selling premium, selling insurance

You define a basket of stocks that you would like to own - but at a lower price than what is currently being offered. You sell out of the money puts 1,2 months out - but not exceed your capability to buy/own every single stock behind he puts sold. In a choppy market, stock gets "put" to you over time. Each time it gets put to you - you can attempt to sell a "call" covered because you own the underlying and collect the premium on both sides (put and call) and any issued dividends while you own the stock. When the Vix is 18 - 25 this works pretty well. Note that you do not get all the trades you want - you have to mange things carefully. In an environment like now, VIX<15 it is difficult to get much premium going.

 

 

 

Options can also help to "smooth out" abrupt trading behavior

 

R

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I generally prefer to limit risk to the max, so I just do weekly covered calls. To make it sweeter, I do deep ITM weekly covered calls, so that not only I only risk to buy the underlying, but I also give myself a cushion if the stock drops a bit during the week. At the end of the week, I'm happy to have my options exercised and keep the premium. The problem here is to find underlyings that give a good premium and I tried Www.myoptions4profit.com - Stock Market Trading, in-the-money Weekly Covered Calls, Options Trading Strategy. So far (6 weeks), it's been good. May just be a lucky streak, but as long as it's working...

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