Similarities Between Covered Calls and Naked Puts

Covered calls and naked puts have much in common in terms of investment strategy and investor outlook. Both techniques work best in neutral to bullish market conditions. Furthermore, the choices of which stocks to use is similar for both covered calls and naked puts. Lastly, the exit strategies for these two techniques are similar.

Similar to writing a covered call, when selling a naked put, investors are hoping that the stock price for the underlying shares stays the same or increases. If the stock price closes above the strike price, then both the covered call writer and naked put seller are profitable. An example with selling the put: XYZ stock is trading at $50 a share, and you sell a $50 put for $4 a share. If the stock price closes at $52 a share on the strike date, no one is going to want to sell you their shares for $50 a share, therefore you sold the put and kept the premium. However, if the stock price closes at $48 a share on the strike date, the investor will have to buy 100 shares (assuming one contract) of the stock at $50 a share. If you wrote a covered call with the same stock then your stock would be called away with a closing price of $52 a share, and you would still own it with a closing price of $48 a share.

Another similarity between these two approaches is that the choice of the underlying stock is very similar. The reason for this is that investors are looking for stocks that are hopefully going to hold their current price, or increase, between the time of the option sale and the strike date. Therefore, the criteria used for these two techniques will be very similar. Investors should look for good companies with strong fundamentals and try and avoid earnings dates.

The exit strategies used when writing covered calls is similar to the exit strategy used when selling naked puts. Very simply, investors need to watch the stock prices carefully after selling the option, and if they see a slide or there is bad news, they need to buy the options back. When writing covered calls, investors need to buy their calls back and sell out of the stock. When selling naked puts, investors simply need to buy their puts back. There are more exit alternatives that can be used for both covered calls and naked puts, but they are also similar. So for the sake of simplicity, they will not be discussed.

Keep in mind that while there appear to be many similarities between writing covered calls and naked puts, the two strategies have some underlying fundamental differences. Personally, I find that understanding the ways that others invest gives me greater clarity on how I am investing. Therefore, I believe that the covered call writer will actually gain a better high level understanding of covered calls by also understanding naked puts.

1. Covered Calls and Naked Puts Introduction
2. Similarities Between Covered Calls and Naked Puts
3. Differences Between Covered Calls and Naked Puts
4. Summary of Covered Calls and Naked Puts
5. Writing a Covered Call While Also Buying a Put