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Covering calls and selling puts is not as optimal a strategy as it is sometimes sold to be. There are similarities with convertible bonds, which often use the more complex rules to mask its risk and focus on its upside. The same goes for such option strategies, which largely uses complexity to make its downside look uncertain but upside guaranteed.
For your strategy of selling puts, you profit from the premium but it costs you your strategic position in the market. Keeping the capital in cash to cover the put keeps you out of the market, if the stock takes off you will miss it. If the stock plummets, it is not a disaster if your fundamental analysis is correct and the strike price is not overvaluing the stock. But the insidious part of the argument is claiming this is not a loss at all because you would've bought the stock at an even higher price a month ago. The strategy has put you in an unfavorable strategic position, it has an opportunity cost. It becomes more obvious if you keep paying this opportunity cost, you would never benefit from any rise in the stock price.
The covered put strategy has a similar cost. It puts you in an unfavorable strategic position that could see your stock disappear for a slightly higher price than you bought but forces you to eat all the losses to maintain t. It half borrows the argument from value investing that a drop in stock price doesn't matter. But that argument is only valid in the context of a value investing strategy because you can take the downside for an even larger subsequent upside. In this context, which is really a trading strategy trying to put on a mask of value investing, it is a real cost because you would never have any multibaggers but will eat a lot of paper losses. It too has an opportunity cost.
Like convertible bonds it depends on the prices involved. With selling puts its about valuing the strategic position you're giving up. If you sell puts when the premium is 40% of the stock per annum this is more than you could reasonably expect to make buying it straight long. Here there's a very good case for doing this because there is large margin of safety. Even if the strike price is hit and plummets 40% further you still have not even a paper loss. You would own 100% of the stock you were intending to buy a year ago and another 40% in cash. If you ploughed that back into stock, you'd actually end up owning 167% of the amount of stock you initially could buy.
If you're covering calls, a 40% premium with a strike price 10% above the current market price means you're going to make a lot of money before incurring an opportunity cost, so there's a very good argument here.
But as with all investments it depends on circumstances specific to the prices. The very useful information Wildreamz provided shows in practice selling options is not as profitable as some people make it to be. It is undoubtedly profitable at some point, as with any investment the question is judging the price at which it is.
For your strategy of selling puts, you profit from the premium but it costs you your strategic position in the market. Keeping the capital in cash to cover the put keeps you out of the market, if the stock takes off you will miss it. If the stock plummets, it is not a disaster if your fundamental analysis is correct and the strike price is not overvaluing the stock. But the insidious part of the argument is claiming this is not a loss at all because you would've bought the stock at an even higher price a month ago. The strategy has put you in an unfavorable strategic position, it has an opportunity cost. It becomes more obvious if you keep paying this opportunity cost, you would never benefit from any rise in the stock price.
The covered put strategy has a similar cost. It puts you in an unfavorable strategic position that could see your stock disappear for a slightly higher price than you bought but forces you to eat all the losses to maintain t. It half borrows the argument from value investing that a drop in stock price doesn't matter. But that argument is only valid in the context of a value investing strategy because you can take the downside for an even larger subsequent upside. In this context, which is really a trading strategy trying to put on a mask of value investing, it is a real cost because you would never have any multibaggers but will eat a lot of paper losses. It too has an opportunity cost.
Like convertible bonds it depends on the prices involved. With selling puts its about valuing the strategic position you're giving up. If you sell puts when the premium is 40% of the stock per annum this is more than you could reasonably expect to make buying it straight long. Here there's a very good case for doing this because there is large margin of safety. Even if the strike price is hit and plummets 40% further you still have not even a paper loss. You would own 100% of the stock you were intending to buy a year ago and another 40% in cash. If you ploughed that back into stock, you'd actually end up owning 167% of the amount of stock you initially could buy.
If you're covering calls, a 40% premium with a strike price 10% above the current market price means you're going to make a lot of money before incurring an opportunity cost, so there's a very good argument here.
But as with all investments it depends on circumstances specific to the prices. The very useful information Wildreamz provided shows in practice selling options is not as profitable as some people make it to be. It is undoubtedly profitable at some point, as with any investment the question is judging the price at which it is.