MHP Position 1 - Adjustment

The following adjustment was made today on first MHP position:

29-Apr-09 - Buy Back and Roll Out - BTC 1 May09 25.00 Call @ -5.11 -
29-Apr-09 - Interim Trade - STO 1 Jun09 25.00 Call @ 5.39 -

The May09 25.00 call was ITM with less than $0.05 time value and would have resulted in a loss if called, so I rolled it out to a Jun09 25.00 call in order to avoid assignment. I received a net credit on the roll of $28.00.

I decided to split this position into two positions. The second position is also ITM (May09 25 call) and I'll allow it to be called if it's still ITM at May expiration, since it will result in a profit.

Current Position Summary:

Stock Investment: $4.527.00
Income Generated: $557.70
Percent Income Generated: 12.16%
Annualized Income Generated: 11.21%
Net Profit If Called: -$1,476.30
Percent Return If Called: -32.61%
Annualized Return If Called: -30.06%
Days Held to Expiration: 396 days

Trade History:

19-May-08 - Initial Stock Position - BTO 100 MHP @ 45.27 -
19-May-08 - Initial Call Option - STO 1 Jun08 45.00 Call @ 1.64 - Expired
11-Jun-08 - Dividend Received - DIV 100 Dividend @ 0.22 -
07-Jul-08 - Continued Trade - STO 1 Aug08 45.00 Call @ 0.34 - Expired
22-Aug-08 - Continued Trade - STO 1 Sep08 45.00 Call @ 0.51 - Closed
10-Sep-08 - Dividend Received - DIV 100 Dividend @ 0.22 -
23-Sep-08 - Continued Trade - STO 1 Nov08 45.00 Call @ 0.79 - Closed
20-Oct-08 - Buy Back and Roll Down - BTC 1 Nov08 45.00 Call @ -0.21 - Closed
20-Oct-08 - Interim Trade - STO 1 Nov08 35.00 Call @ 0.29 - Expired
24-Nov-08 - Interim Trade - STO 1 Jan09 30.00 Call @ 0.87 - Expired
10-Dec-08 - Dividend Received - DIV 100 Dividend @ 0.22 -
27-Jan-09 - Interim Trade - STO 1 Feb09 22.50 Call @ 0.35 - Closed
09-Feb-09 - Buy Back and Roll Out/Up - BTC 1 Feb09 22.50 Call @ -3.30 -
09-Feb-09 - Interim Trade - STO 1 Mar09 25.00 Call @ 1.89 - Expired
11-Mar-09 - Dividend Received - DIV 100 Dividend @ 0.23 -
24-Mar-09 - Interim Trade - STO 1 May09 25.00 Call @ 1.16 - Closed
29-Apr-09 - Buy Back and Roll Out - BTC 1 May09 25.00 Call @ -5.11 -
29-Apr-09 - Interim Trade - STO 1 Jun09 25.00 Call @ 5.39 -

Covered Calls and Naked Puts: Synthetic Equivalents

Covered calls and naked puts are synthetic equivalents. They have the same risk/reward profile, meaning they have the same net investment and profit/loss potential, when done at the same strike and expiration. To fully understand this concept you need to understand synthetic positions, put/call parity, options arbitrage, and conversion/reversal arbitrage.

Here are links to 4 articles that explain these topics in detail:

1. Synthetic Positions
   
   
2. Put/Call Parity
   
   
3. Options Arbitrage
   
   
4. Conversion/Reversal Arbitrage

These are some pretty complex topics but they're essential for understanding why a covered call is the same as a naked put, and vice versa.

PSUN - Adjustment

The following adjustments were made today on PSUN:

21-Apr-09 - Interim Trade - STO 4 Jun09 5.00 Call @ 0.19 -

Current Position Summary:

Stock Investment: $9,108.00
Income Generated: $1,819.80
Percent Income Generated: 19.28%
Annualized Income Generated: 5.58%
Net Profit If Called: -$5,288.20
Percent Return If Called: -58.06%
Annualized Return If Called: -16.23%
Days Held to Expiration: 1306 days

Trade History:

21-Nov-05 - Initial Stock Position - BTO 200 PSUN @ 26.39 -
21-Nov-05 - Initial Call Option - STO 2 Dec05 25.00 Call @ 1.84 - Expired
20-Dec-05 - Continued Trade - STO 2 Jan06 25.00 Call @ 0.69 - Expired
23-Jan-06 - Continued Trade - STO 2 Mar06 25.00 Call @ 0.74 - Expired
20-Mar-06 - Continued Trade - STO 2 Jun06 25.00 Call @ 0.64 - Expired
26-Jun-06 - Second Stock Position - BTO 200 PSUN @ 19.16 -
26-Jun-06 - Combined Cost Basis - $9,108.00 400 @ 22.77 -
26-Jun-06 - Continued Trade - STO 4 Dec06 22.50 Call @ 0.69 - Closed
18-Sep-06 - Buy Back & Roll Out/Down - BTC 4 Dec06 22.50 Call @ -0.16 -
18-Sep-06 - Interim Trade - STO 4 Jan07 17.50 Call @ 0.54 - Closed
18-Dec-06 - Buy Back & Roll Out/Up - BTC 4 Jan07 17.50 Call @ -3.01 -
18-Dec-06 - Continued Trade - STO 4 Jan09 22.50 Call @ 3.69 - Closed
07-Jan-08 - Buy Back - BTC 4 Jan09 22.50 Call @ -0.61 -
24-Jan-08 - Interim Trade - STO 4 Jun08 12.50 Call @ 0.74 - Closed
22-May-08 - Buy Back & Roll Out - BTC 4 Jun08 12.50 Call @ -0.11 -
22-May-08 - Interim Trade - STO 4 Jul08 12.50 Call @ 0.23 - Expired
22-Jul-08 - Interim Trade - STO 2 Jan09 12.50 Call @ 0.32 - Expired
22-Jul-08 - Interim Trade - STO 2 Sep08 10.00 Call @ 0.31 - Closed
12-Sep-08 - Buy Back & Roll Out - BTC 2 Sep08 10.00 Call @ -0.04 -
12-Sep-08 - Interim Trade - STO 2 Jan09 10.00 Call @ 0.14 - Expired
21-Apr-09 - Interim Trade - STO 4 Jun09 5.00 Call @ 0.19 -

PFE - Adjustment

The following adjustment was made today on PFE:

21-Apr-09 - Interim Trade - STO 2 Jun09 15.00 Call @ 0.20 -

Current Position Summary:

Stock Investment: $4,565.00
Income Generated: $741.00
Percent Income Generated: 16.23%
Annualized Income Generated: 11.57%
Net Profit If Called: -$824.00
Percent Return If Called: -18.05%
Annualized Return If Called: -12.87%
Days Held to Expiration: 512 days

Trade History:

24-Jan-08 - Initial Stock Position - BTO 200 PFE @ 22.83 -
24-Jan-08 - Initial Call Option - STO 2 Mar08 22.50 Call @ 0.96 - Expired
04-Mar-08 - Dividend Received - DIV 200 Dividend @ 0.32 -
25-Mar-08 - Continued Trade - STO 2 Jun08 22.50 Call @ 0.24 - Expired
03-Jun-08 - Dividend Received - DIV 200 Dividend @ 0.32 -
24-Jul-08 - Continued Trade - STO 1 Dec08 22.50 Call @ 0.22 -
24-Jul-08 - Continued Trade - STO 1 Dec08 22.50 Call @ 0.22 - Expired
29-Jul-08 - Continued Trade - STO 1 Dec08 22.50 Call @ 0.14 - Expired
03-Sep-08 - Dividend Received - DIV 200 Dividend @ 0.32 -
02-Dec-08 - Dividend Received - DIV 200 Dividend @ 0.32 -
22-Dec-08 - Interim Trade - STO 2 Mar09 20.00 Call @ 0.31 - Expired
03-Mar-09 - Dividend Received - DIV 200 Dividend @ 0.32 -
24-Mar-09 - Interim Trade - STO 2 Apr09 15.00 Call @ 0.20 - Expired
21-Apr-09 - Interim Trade - STO 2 Jun09 15.00 Call @ 0.20 -

LLY - Adjustment

The following adjustment was made today on LLY:

21-Apr-09 - Interim Trade - STO 1 May09 35.00 Call @ 0.49 -

Current Position Summary:

Stock Investment: $4,971.00
Income Generated: $691.30
Percent Income Generated: 13.91%
Annualized Income Generated: 13.43%
Net Profit If Called: -$779.70
Percent Return If Called: -15.68%
Annualized Return If Called: -15.15%
Days Held to Expiration: 378 days

Trade History:

02-May-08 - Initial Stock Position - BTO 100 LLY @ 49.71 -
02-May-08 - Initial Call Option - STO 1 Jun08 50.00 Call @ 1.29 - Expired
10-Jun-08 - Dividend Received - DIV 100 Dividend @ 0.47 -
07-Jul-08 - Continued Trade - STO 1 Aug08 50.00 Call @ 0.29 - Expired
22-Aug-08 - Continued Trade - STO 1 Sep08 50.00 Call @ 0.32 - Expired
10-Sep-08 - Dividend Received - DIV 100 Dividend @ 0.47 -
23-Sep-08 - Continued Trade - STO 1 Oct08 50.00 Call @ 0.40 - Expired
20-Oct-08 - Interim Trade - STO 1 Nov08 40.00 Call @ 0.19 - Expired
24-Nov-08 - Interim Trade - STO 1 Jan09 40.00 Call @ 0.39 - Expired
10-Dec-08 - Dividend Received - DIV 100 Dividend @ 0.47 -
29-Jan-09 - Interim Trade - STO 1 Mar09 40.00 Call @ 0.90 - Expired
10-Mar-09 - Dividend Received - DIV 100 Dividend @ 0.49 -
24-Mar-09 - Interim Trade - STO 1 Apr09 35.00 Call @ 0.74 - Expired
21-Apr-09 - Interim Trade - STO 1 May09 35.00 Call @ 0.49 -

JNJ - Adjustment

The following adjustment was made today on JNJ:

21-Apr-09 - Continued Trade - STO 1 May09 55.00 Call @ 0.30 -

Current Position Summary:

Stock Investment: $6,146.00
Income Generated: $882.20
Percent Income Generated: 14.35%
Annualized Income Generated: 27.15%
Net Profit If Called: $236.20
Percent Return If Called: 3.84%
Annualized Return If Called: 7.27%
Days Held to Expiration: 193 days

Trade History:

03-Nov-08 - Initial Stock Position - BTO 100 JNJ @ 61.46 -
03-Nov-08 - Initial Call Option - STO 1 Nov08 60.00 Call @ 2.95 - Expired
24-Nov-08 - Continued Trade - STO 1 Dec08 60.00 Call @ 1.90 - Expired
22-Dec-08 - Continued Trade - STO 1 Jan09 60.00 Call @ 1.45 - Expired
22-Jan-09 - Continued Trade - STO 1 Mar09 60.00 Call @ 0.95 - Expired
10-Mar-09 - Dividend Received - DIV 100 Dividend @ 0.46 -
24-Mar-09 - Continued Trade - STO 1 Apr09 55.00 Call @ 0.80 - Expired
21-Apr-09 - Continued Trade - STO 1 May09 55.00 Call @ 0.30 -

ADP - Adjustment

The following adjustment was made today on ADP:

21-Apr-09 - Interim Trade - STO 1 May09 39.00 Call @ 0.34 -

Current Position Summary:

Stock Investment: $4,308.00
Income Generated: $571.00
Percent Income Generated: 13.25%
Annualized Income Generated: 20.67%
Net Profit If Called: $163.00
Percent Return If Called: 3.78%
Annualized Return If Called: 5.90%
Days Held to Expiration: 234 days

Trade History:

23-Sep-08 - Initial Stock Position - BTO 100 ADP @ 43.08 -
23-Sep-08 - Initial Call Option - STO 1 Oct08 42.50 Call @ 1.75 - Expired
20-Oct-08 - Interim Trade - STO 1 Nov08 37.50 Call @ 0.84 - Expired
24-Nov-08 - Interim Trade - STO 1 Dec08 40.00 Call @ 0.46 - Expired
22-Dec-08 - Continued Trade - STO 1 Feb09 42.50 Call @ 0.91 - Expired
01-Jan-09 - Dividend Received - DIV 100 Dividend @ 0.33 -
24-Feb-09 - Interim Trade - STO 1 Apr09 37.50 Call @ 0.75 - Expired
01-Apr-09 - Dividend Received - DIV 100 Dividend @ 0.33 -
21-Apr-09 - Interim Trade - STO 1 May09 39.00 Call @ 0.34 -

Paper Trade - Covered Call & Naked Put

There's been a lot of discussion on the JustCoveredCalls Yahoo group on covered calls (CC) vs naked/cash secured puts (NP/CSP). Both strategies are synthetic equivalents of each other and have the same risk/reward profile when done at the same strike/expiration. Due to put/call parity, these strategies have about the same net investment and dollar amount return. However, there are differences in capital requirements, especially when trading in a margin account.

Selling an OTM put has about the same net investment and dollar amount return as an ITM covered call with the same strike/expiration (e.g. $20 ITM May CC will be about the same as selling a $20 OTM May NP/CSP).

For those unfamiliar with naked/cash secured puts, let me provide a brief explanation. When you sell a put option you are obligated to buy the stock at the strike price of the put if assigned. So, for example, if a stock is trading for $25 and you sell an OTM $20 strike put, you agree to buy 100 shares of stock at $20/share, or $2,000. You either need to have $2,000 in cash to secure the put or you must have a margin account. At expiration, if the stock stays at $25, the put expires and you get to keep the premium. If the stock falls below $20 the put will be exercised and you'll have to buy 100 shares for $2,000.

This would be the same as buying the stock at $25 and selling an ITM $20 strike call. At expiration, if the stock stays at $25, the call will be exercised and you'll have to sell 100 shares for $2,000. If the stock falls below $20 the call expires and you get to keep the premium. Same results as the NP/CSP only in reverse.

In a margin account, you only need to put up about 20% or $400, depending on your broker, even if you have the entire $2,000 in cash. This dramatically reduces your capital requirement and increases your percentage profit, even though the profit amount is about the same as a covered call. Margin requirements for the stock portion of a CC are usually 50%, depending on your broker. So, you can see that there's a clear margin advantage to trading NP/CSP's vs CC's, even though both strategies are essentially the same.

In a non-margin account, like an IRA, the put MUST be fully secured by cash (i.e. a CSP), so you MUST have $2,000 in cash, to cover the cost of the stock. In this case, $2,000 is deducted from the cash available for investment, so even though the $2,000 remains in your account, you can't spend it. However, you do earn interest on that $2,000, but remember options pricing takes interest and dividends into account, so their impact is minimized when comparing CC's vs NP/CSP's.

Since the members of the JustCoveredCalls Yahoo group recently voted to include NP/CSP's in our discussions, I thought I would start a paper trade example on my blog. Since I trade in an IRA I will use 100% cash secured puts and compare that to a traditional covered call.

On 4/9 I established a new CC position on TGT which I'll use for this example. I created a paper trade for the CSP position which I'll adjust at the same time as the CC position over the next several months. Here are the details of both positions:

TGT CC Position (Real Position)

09-Apr-09 - Initial Stock Position - BTO 100 TGT @ 39.78
09-Apr-09 - Initial Call Option - STO 1 May09 37.50 Call @ 3.70

Capital Invested: $3,978.00
Income Generated: $370.00
Net Investment: $3,608.00
Percent Income Generated: 9.30%
Annualized Income Generated: 94.30%
Net Profit If Called: $142.00
Percent Return If Called: 3.57%
Annualized Return If Called: 36.19%
Days Held to Expiration: 36 days

TGT CSP Position (Paper Position)

09-Apr-09 - Initial Put Option - STO 1 May09 37.50 Put @ 1.54

Capital Invested: $3,750.00
Income Generated: $144.00
Net Investment: $3,606.00
Percent Income Generated: 3.84%
Annualized Income Generated: 38.93%
Net Profit If Expired: $144.00
Percent Return If Expired: 3.84%
Annualized Return If Expired: 38.93%
Days Held to Expiration: 36 days

As you can see, the net investment and dollar profit is about the same. However, the capital invested in the CC is greater than the capital invested (cash required to secure the put) in the CSP. If the CC is called away and the CSP expires, the CSP will have a higher percentage return, even though the dollar amount return is about the same, due to the lower capital requirement. If the CC is not called and the CSP is assigned, then the CC will generate more cash and have a higher yield than the CSP. So, there are trade offs for either result.

If TGT is still above $37.50 by May expiration, I'll roll the CC position to avoid assignment and roll the CSP at the same time. If TGT is below $37.50 by May expiration, I'll roll the CSP to avoid assignment and roll the CC at the same time. I'll do this for a few months so we can see the long term affect of using both strategies. TGT also pays a dividend, so we will also see the affects that will have on both positions. For simplicity sake, I will not include interest in these examples, since that's a bit harder to track.

Anyway, I hope this will be a useful exercise and help people understand the similarities and differences of these two strategies.

PFCB Position #2 - Closed

The PFCB Apr09 25.00 call was exercised on Fri and the stock was called away for a profit.

This was the second half of the PFCB position, which was the result of averaging down in Dec08. I decided to allow this second position to be called away since it resulted in a nice profit. I'm still holding the original 100 shares and will continue with that positions until it too can be called away for a profit.

The following is the trade history and returns, including IB commissions.

Covered Call Results

Stock Investment: $2,273.00
Income Generated: $289.30
Net Profit: $516.30
Percent Return: 22.71%
Annualized Return: 64.77%
Duration of Trade: 128 days

Trade History:

10-Dec-08 - Second Stock Position - BTO 100 PFCB @ 22.73 -
10-Dec-08 - Interim Trade - STO 1 Apr09 25.00 Call @ 2.89 - Exercised
17-Apr-09 - Option Exercised - EX 1 Apr09 25.00 Call @ 25.00 -

CRI - Closed

The CRI Apr09 20.00 call was exercised on Fri and the stock was called away for a profit.

This is a good example of a stock that declined by over 52% during the first year that I owned it. By averaging down and selling calls I lowered my cost basis and ended up with an 11.43% annualized return in about 2 years, even though the stock is still down over 18% from the initial purchase price.

The following is the trade history and returns, including IB commissions.

Covered Call Results

Stock Investment: $4,049.00
Income Generated: $896.20
Net Profit: $847.20
Percent Return: 20.92%
Annualized Return: 11.43%
Duration of Trade: 668 days

Trade History:

19-Jun-07 - Initial Stock Position - BTO 100 CRI @ 26.54 -
19-Jun-07 - Initial Call Option - STO 1 Sep07 25.00 Call @ 2.99 - Expired
24-Sep-07 - Interim Trade - STO 1 Dec07 22.50 Call @ 0.69 - Expired
14-Jan-08 - Interim Trade - STO 1 Mar08 20.00 Call @ 0.49 - Expired
25-Mar-08 - Interim Trade - STO 1 Apr08 17.50 Call @ 0.24 - Expired
24-Apr-08 - Second Stock Position - BTO 100 CRI @ 13.95 -
24-Apr-08 - Combined Cost Basis - $4,049.00 200 @ 20.25 -
24-Apr-08 - Interim Trade - STO 2 Sep08 17.50 Call @ 0.64 - Closed
12-Sep-08 - Buy Back & Roll Out/Up - BTC 2 Sep08 17.50 Call @ -2.16 -
12-Sep-08 - Continued Trade - STO 2 Dec08 20.00 Call @ 1.60 - Expired
22-Dec-08 - Continued Trade - STO 2 Jan09 20.00 Call @ 0.76 - Expired
22-Jan-09 - Continued Trade - STO 2 Mar09 20.00 Call @ 0.84 - Expired
24-Mar-09 - Continued Trade - STO 2 Apr09 20.00 Call @ 0.58 - Exercised
17-Apr-09 - Option Exercised - EX 2 Apr09 20.00 Call @ 20.00 -