Comparing Similar Covered Call Writing and Put-Selling Positions

Covered call writing and selling cash-secured puts are similar strategies that do have certain differences. In my book, Selling Cash-Secured Puts, Figure 68 on page 214 highlights the similarities and differences between these two strategies. In this article, I will show a real-life example of how analogous positions in each strategy frequently will yield similar returns with similar protection and therefore comparable risk-reward profiles.

Trade data

To demonstrate the mathematics of our two positions we will use the following data obtained from an options chain for Adobe Systems, Inc. (ADBE) on 12/29/2015:

• ADBE is trading at $93.66
• We are hypothetically bearish on the market and will favor in-the-money calls and out-of-the-money puts
• The February 19, 2016 $92.50 call trades at $3.90 (see screenshot below left side)
• The February 19, 2016 $92.50 put trades at $2.60 (see screenshot below right side)
• Option chain data will be calculated by the Ellman (BCI) Calculators

Call calculations

Calculating Call Returns for ADBE

Put calculations

Put Calculations for ADBE

Similarities in returns

• Call returns (ROO or time value only) comes in at 3.0% while the ROO for the put positions calculates to a similar 2.89%
• These are both the maximum profits achievable

Similarities in protection

The Ellman Calculator for covered call writing (top chart) shows a downside protection of 1.2%. This relates to protection of the initial profit or ROO (3.0%). You will note that the actual position breakeven is $89.76 which represents 4.2% of protection down to breakeven ($3.90/$93.66). On the lower screenshot of the put calculator we see a breakeven (stock cost basis, if exercised) at $89.90, a 4.01% discount from $93.66.

Discussion

Comparable covered call writing and put-selling positions will generate similar risk-reward profiles. In the real-life example presented in this article, both put and call strikes were $1.16 either in- or out-of-the-money. Both positions yielded returns near 3% with protection to breakeven of near 4%. It is certainly to our advantage to master the similarities and differences between these two strategies so we may take advantages of their strengths and weaknesses.

April 26, 2016

Market tone

• Global stocks rose this week as China’s economy showed more signs of stabilization. The Chicago Board Options Exchange Volatility Index (VIX) fell to 13.90 from 15.20. Oil prices rose on hopes for production caps from major oil-producing nations at a meeting in Doha this weekend. This week’s reports and international news of import:
• In China, industrial production, retail sales and fixed asset investment all rebounded in March following disappointing reports in February
• A Brazilian congressional committee recommended impeachment earlier this week to remove President Dilma Rousseff from office
• Claims for state unemployment insurance fell to their lowest level since 1973, a bullish signal for our economy. Only 253,000 first-time claims were filed
• Global oil supply will move closer to balance late this year, according to the International Energy Agency.  The oversupply is expected to fall to 200,000 barrels per day from 1.5 million barrels per day in the first half of 2016
• The global economy is expected to grow 3.2% in 2016 and 3.5% in 2017, according to recent International Monetary Fund projections
• The Italian government agreed on a draft plan to support the banking system
• British prime minister David Cameron finds himself embroiled in the Panama Papers scandal as he tries to lead the “remain” campaign ahead of the June 23rd referendum on UK membership in the European Union. The average of six recent polls points to a statistical dead heat.
• US banking regulators gave failing grades to five of the eight largest banks in the United States on their bankruptcy and liquidation plans in the event of the banks’ failure. The plans were a requirement of the 2010 Dodd-Frank Act. The five banks have until October to amend their plans to the satisfaction of the US Federal Reserve and the Federal Deposit Insurance Corporation
• Earnings season kicked off this week. While only a small fraction of S&P 500 companies have reported Q1 earnings, early results have been excellent as 79% reported earnings that exceeded analyst expectations, while 21% reported earnings below expectations

THE WEEK AHEAD

•OPEC and non-OPEC oil producing countries meet in Doha on Sunday April 17th to discuss a production cap

•The spring meeting of the International Monetary Fund and the World Bank concludes on Sunday April 17th

•New York Federal Reserve Bank president William Dudley speaks on Monday April 18th

•The European Central Bank holds a rate-setting meeting on Thursday April 21st

For the week, the S&P 500 rose by 1.62% for a year-to-date return of 1.80%.

Summary

IBD: Market in confirmed uptrend

GMI: 4/6- Buy signal since market close of March 2nd

BCI: Moderately bullish, favoring out-of-the-money strikes 2-to-1. A good first week of earnings season.

Wishing you the best in investing,

Alan (alan@thebluecollarinvestor.com)