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Nothing presented is financial advice, trading advice or recommendations. Everything presented is the author's ideas only. The author accepts no liability for its use including errors and omissions. You alone are solely responsible for your own investing and trading. There are considerable risks involved in implementing any investment strategies and losses can be large. Trade at your own risk.

 

 

 

April 2 2011  / Opinion Article - Selling Stock Options
Why I Believe
Selling Puts Is Superior To Covered Calls


Introduction

The debate over whether selling puts or selling covered calls are basically the same strategy has raged for years. They are both selling stock option strategies. Go to any financial forum and post a note about how you feel as an investor that covered calls are better or naked puts are better and you will stir up a debate.

Over 35 years ago when
options on many stocks were just getting started I was introduced to selling stock options such as naked put selling as a means to lower my overall cost of entry into a stock. However as the years have passed I have developed various strategies that have shown to me how flexible and truly exceptional naked puts are in the arsenal of investing. Leaving aside tax implications involved in covered calls and naked puts, I believe naked put selling is far superior to covered calls and here are my 10 main reasons:

1) The obvious - I can buy into a stock at a discount to the prevailing stock price. If I am wrong and the stock moves higher, I am paid a premium for my effort. All the while my capital sits aside earning interest.

2) Covered call investing has two parts to the trade and two commissions to be paid. First I have to tie up my capital in the stock and then sell the call. If the stock falls, I can try to get out of the stock but normally this will result in a capital loss and if I close my covered calls, I am back paying two more commissions. With selling puts I sell the put and keep my capital earning interest. I pay one commission. Meanwhile as the expiry date arrives, the premium evaporates on the put, and all the while my capital still sits waiting. If the stock should pullback and place my sold puts in the money, I can buy back and roll out the puts either further out in time for even more premium or roll it down to follow the stock lower. When I roll lower, often I can roll further out in time and still move lower for a net credit rather than debit. Many times I can follow the stock lower and still earn a credit.

 

3) With Naked Puts as my capital is not invested, my margin amount is higher allowing me to write more naked puts. In an uptrending market this can really add to my profit. I can often write a lot more naked puts than I can covered calls on the same stock as more margin is available to me. An investor though has to be careful and prudent as this can be a recipe for disaster if an investor sells more puts that they can actually handle.

 

4) Selling stock options such as covered calls with leaps is even worse as it ties up my capital for an even longer period of time. Selling Leap Naked Puts allows my capital to be free for a longer period of time, earning interest and being applied to other trades. I can often time my trades so that I know how much capital I will need when the leaps expire and this gives me months to apply my capital to other naked put trades until the leap put gets closer to expiry. Basically I can almost double up on my capital. Therefore I often sell a few leap puts on all my positions just to garner more income and who knows, maybe I will end up owning the stock at a greatly reduced price.

 

5) Selling Puts almost always allows me to determine when I want to be assigned the shares. As long as I monitor the naked put and roll it prior to it expiring (Normally I roll about a 3 to 1 week before depending on the price of the stock) I am almost always able to avoid being assigned.

 

6) This one bears repeating - selling covered calls takes two commissions while naked puts takes just one.

 

7) You might say, "wait, when I sell a covered call I can sell above the stock price and earn the call premium and should the stock move higher I also have an additional capital gain." This is definitely true. However often I check the 10 day simple moving average against the 20 and 30 day exponential moving average. If the 10 day is showing an uptrend, then I sell a slightly ITM naked put and if the stock moves up I reap the share price increase and I am still holding the naked put. If the share price moves above the naked put price by expiry then I have captured all the put option premium AND had the put expire worthless. How great is that! On my website I show how I have used this strategy often. I call it "Walk That Profit Home To Mama" and in an uptrending market it can work wonders.

 

8) On stocks that are in an uptrend, I can sell a string of naked puts and capture premium all the way up and still end up with my capital intact in an investment account and enjoy the gains of the stock without ever owning it. I did this on the rise in XOM starting in September 2010. While not as good as actually owning the stock outright, it gives me greater flexibility as I can sell naked put contracts as the stock rises, close them for a profit if the stock continues to rise and sell contracts higher, following the rise in the stock. When the uptrend begins to stall, I can close my naked puts and be done with the stock, or I can look the position over and decide to close and sell naked puts further out in time in case the stock again moves higher or if it moves lower, to capture more premium on naked puts as the stock begins to fall back.

9) Finally, the most amazing strategy that I enjoy is rolling my puts constantly and garnering the income from put premiums, until eventually I am no longer using my own capital, but other investor's capital. In Oct 2008 I began selling naked puts on Kraft and by June 2010 I had earned enough capital to purchase 500 shares and move my own capital to another stock and commence the same strategy. This is the ultimate in investing - owning shares that did not require my own capital. This trade is also on my site under my US Portfolio. Meanwhile Kraft during that period moved about 6 or 7 dollars, from its low during the financial crisis to its high in 2010. 

 

10) Finally my last example is using naked put income to sell even more puts. How great a thing is that - making money on other investors' money. Leap puts are great for this strategy. Take Coca Cola for example. On Feb 4 2010 I looked at Coca Cola and felt that I would be happy to own the stock at the $55.00 strike. The stock was trading at 53.43. I sold the Jan 2010 $55 naked put for $6.05. If assigned at $55.00 my cost basis in the stock would have been $48.95. On the other hand, if I was wrong and the stock rose above $55.00, I was being paid 6.05 or 11% to wait. I sold the puts, earned the capital, used that capital to sell more puts on Kraft and meanwhile had no funds tied into either Coca Cola or Kraft shares. So now I was using other people's money to not only help pay for any possible assignment on Coca Cola, but to sell naked puts on Kraft. My Coke trade, which is still ongoing, can be seen on my website, under the US Portfolio
 

Summary

The flexibility of selling puts can not be overstated. These are just 10 points. Over the years I have developed many naked put selling strategies. Everything from rescuing stock positions that had large losses, to earning income from rapidly rising stocks without ever owning the shares. When selling stock options, naked puts are my number one choice of investment vehicles in my arsenal of tools. With them I fear no swings in the market. In actuality I welcome them as every rise in volatility just increases their premiums. I believe every investors should study and paper trade naked put strategies until they find those strategies that assist them in earning capital and protecting their assets.

 

You can tell that I am sold on Naked Put selling and believe it is superior to covered call writing. That being said, in Canada, Retirement Accounts referred to as RRSP do not allow put selling, which is incredibly sad and a big reason why I like to keep a large portion of my investments outside my RRSP. In the United States this is not the case as investors in the US are allowed to sell cash secured naked puts. (Basically the cash must be in their account to cover the stock cost should it be assigned) If you have any additional ideas, suggestions, comments, even arguments, email me through this form.


 


 

Disclaimer: There are considerable risks involved in all investment strategies. Trade at your own risk.
Stocks, options and investing are risky and can result in considerable losses. None of the strategies, stocks or information discussed or presented are financial advice, trading advice or recommendations. Fullyinformed.com is a private website. Everything presented and discussed are the author's ideas and opinions only.
By using this site, you agree to be bound by its terms of use. The full terms of use can be read here. If you do not agree to the terms of use, do not use this site. The author of fullyinformed.com assumes no liability for topics and ideas discussed, errors and omissions, ads and their content and external links. Any corporate insignia used are registered trademarks of their respective company or corporation and are being used for identification purposes only. All material copyrighted by FullyInformed.com. Reproduction in whole or in part prohibited. Copyright 2008

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