3. Covered Puts and Calls

Covered positions are used by conservative investors who are willing to accept a cap on their maximum gain in return for a hedge that can offset potential losses. Covered calls—long stock combined with short calls—are the most popular and best understood. Many investors find that covered calls are more profitable than simple long stock positions when the tendency is to hold the stock for a long period.

Bearish investors often take the same approach by shorting a stock and selling puts. As we will see, covered put positions display trading dynamics that are very different from their covered call counterparts. Most of the difference is related to spikes in implied volatility that often occur when a stock suddenly falls. ...

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