COVERED CALLS . . . GOTCHA COVERED
The name “covered calls” alone is comforting—even if you don’t know what it is! Who doesn’t want to be covered? As in, “Hey, dude! Don’t sweat it; we gotcha covered.” Or, “If you’re cold, get covered up.” Just sounds right.
Technically, covered calls combine a long stock position and a written call option. Many investors like these because they get a little bit of instant income from the premium received from selling the call. And there’s not much risk from the call option. If the stock rises to the strike price before the expiration date, you just hand over the stock. That’s why it’s covered. Sounds safe! Income and seemingly low risk! How cool is that? That’s how they are usually sold in the brokerage world.
At the same time, most folks who like covered calls and think they’re safe will say with certainty that naked puts are risky. Covered is safe, but naked is crazy risky! Naked just sounds bad. “Hey, dude, you’re hanging out there naked.” Or, “I was warm until I got naked in the snow.” But naked and covered don’t mean what you may think or what most investors think. In this case, and counter to what every single covered call operator I’ve ever seen believes, they mean mathematically exactly the same thing—as I’ll show you.
A naked put involves a written put option, so you still get the premium income, but you don’t have a position in the underlying security—you’re naked. I guess only nudists don’t fear that. And naked means your loss ...