Covered call

Hi guys, isn’t the covered call a type of protection against downside losses? Upon reading my notes, I found this: A covered call is selling the call while owning the underlying asset. Also, I found this: If we own an underlying asset, an insurance strategy would be to buy a put on the underlying asset. Are they both correct? I. Thought that a covered a call was a type of insurance strategy. Am I wrong? I guess I’m getting confused with the terminology. Any thoughts would be appreciated. Thanks!

both correct covered call and protective put. both own the underlying asset.

So is buying a put equal to selling a call, assuming you own the underlying asset?

A covered call is not really an insurance strategy. It’s an income producing strategy designed to be used when the underlying equity security is expected to produce flat returns. i.e. I own CVX (Chevron). Let’s say I bought 100 shares @$100 and now I want a little income from my position because I believe CVX really isn’t going to move up anytime soon. I then sell/write a covered call for my shares to someone else. Let’s say I sold a July $110 CVX Call into the market for $200. That $200 is mine to keep regardless of what happens to CVX’s price so long as I don’t buy the contract back and sell my shares. It’s like receiving a dividend. Had I not sold the covered call: My Max loss is -$10,000 (Supposing CVX went to $0) Selling the covered call: Max loss is -$10,000+$200 = -$9,800 Covered calls aren’t really an insurance policy, but rather they provide a cushioning affect to losses. Covered calls do not provide nearly the same amount of protection as puts.

Chuck, you rock!!! Thanks that makes slot of sense.

nope you can see it easily if you draw the structure the protective put and underlying looks like a long call position. and covered call combines to structure like a short put. most of the time you write call to collect the premium. :slight_smile:

Thanks sherbet, you guys are all so helpful :slight_smile:

canadianalyst look for a post from dreary about delta hedging selling calls. I remember him explaining it well. Its counter intuitive but can work. There was a question on one of the mocks about it. Basically, if you sell a call you can use a delta hedge to offset some of the price declines. when price drops you sell more calls, then when it drops again you sell more calls. Seems asinine to me but it was in a mock and in the CFAI material. Its the only way selling a call can be an insurance policy against a long stock position.

Thanks stingreye . You guys are so quick to respond! Makes me feel like I’ve been slacking!

Just a rant that hopefully the CFAI hears, but the idea of delta hedging is so impractical. You would have to buy/sell calls every single time the price moved and the delta of your options changed. The transaction costs would easily eat away any use of the hedge. Sound good in theory, but this is the real world.

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