Covered call or protective put for protection?

Covered call or protective put for protection?

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Covered
call or protective put for protection?

 

After trading in the market for
decades, I cannot think of a more commonly asked question amongst traders.  Each side is vehemently passionate about
which one is correct!!!  You definitely
can’t have it both ways and I laugh at the arguments.  Do you want protection with a credit or are
you willing to pay for protection?  As
always let’s let the numbers do the talking and I am going to let you decide
which works best for you.  In all reality
it is a matter of risk tolerance but you will know at the end which side of the
fence I sit on. 

                 

The covered call is the only way to
go Hurley !!!!  I hear this all the
time.  It is usually followed by one of
these types of comments:  Don’t you want
to get paid to play?  I like credit
spreads or I want to take in a credit to pay for my protection.  I am going to create a quick fictitious
example and the numbers are going to do the talking.

 

I buy to open a stock that costs me
$100 a share.

I sell to open a monthly 105 strike
call for $3.00 a share credit.

Net cost basis is $100 stock price
minus a $3 a share credit equals $97 per share.

 

I now have a lower cost basis as I
enter the trade.  I pay $97 dollars
instead of $100 per share.  I have a 3%
downside protection but, I am obligated to sell my stock at $105 a share.  I cap my profit for the 3% downside
protection.  It gives me a little
downside risk to sell out of the position or get stopped out if I use a stop
loss.  In an ideal situation I keep the
credit and the stock moves bullish but doesn’t quite hit the $105 price.  That would be the best of both worlds keeping
the credit when the option expires and having stock appreciation. 

 

My risk is $97 a share or 97% of
the total capital invested even if I never plan lose that much.  Also, I run the risk of a stop loss falling
thru and maybe being triggered at a much lower price than $97 a share.  The stop loss can be triggered at the market
open and at times if a stock is falling fast it might get triggered at a much
lower price than you expect.    Having
97% of my total invested capital at risk may or may not be considered
protection.  What do you think?

 

The protective put is one of my
favorite trades.  It is a debit trade
that I pay to play in the trade.  I am
buying the right to sell my stock at a certain price for a certain period of
time.  I buy insurance on stock would be
the simple explanation.  Let’s look at
these numbers:

 

I buy to open a stock that costs me
$100 a share.

I buy to open a quarterly 100
strike put for $7.00 a share debit.

Net cost basis is $100 stock price
plus a $7 a share debit equals $107 per share.

 

I now have a higher cost basis as I
enter the trade.  I pay $107 dollars
instead of $100 per share of stock or $97 like the covered call.  The good news is that I have a 7% total risk
in the trade with downside protection all the way down to zero.  I have the right to sell my stock at $100 a
share where I bought the shares.  I have
NO cap to the potential upside movement on the stock, but I need the stock to
move at least 7% pay for the protection. 
It gives me a fixed downside risk no matter how far down the stock may
trade.  In an ideal situation stock goes
through an earnings event and shoots to the moon. 

 

Which is best?  It all depends on your risk tolerance.  Can you handle 3% protection or do you want
93% protection?  Are you willing to spend
money to make money or do you want a credit? 
How well do you know your stock and are you able to handle the
unexpected?  Each to his own but the
numbers speaks volumes to me.  I prefer
to trade with as little risk as possible. 
I am not in the market to take unnecessary risk but to make a consistent
boring return in bullish markets.  I must
say I like making up downside bearish movement with an option acting like
insurance on my stock.  Why?  If I am in my stock positions I never miss
upside movement on my stock!!! 

 





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4 Comments
  1. I am still new at matters like the stock market and buying shares. Although I’ve attended seminars and similar events to increase my knowledge, it would still be easy to talk to someone who has the know-how information on doing it right with less risks. Of course, when you do trading, it is with risks and you can either lose or gain money depending on the stocks you’ve bought. I would also choose the covered call. I think if this is discussed at the seminars I attended, it is one more information they gained.

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