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Options course · Lesson 6 of 10

A covered call and a cash-secured put are almost the same trade.

Both trades sell an option to collect income. One starts with the stock and one starts with cash. At the same strike, they have the same shape.

EDUCATION, NOT ADVICE · Options can lose all of their value quickly. The example stock. Every price in this course comes from the Black-Scholes model for one example stock: price $100, volatility 25% a year, interest rate 4%, no dividends, 90 days to expiration. Real quotes differ. Full disclosures →

The covered call

You own 100 shares at $100. You sell one 110 call and receive $189. If the stock ends above $110, the call buyer exercises and you sell your shares at $110.

Own 100 shares and sell the 110 call for $189. -$4,000 -$3,000 -$2,000 -$1,000 $0 +$1,000 today $100 $98.11 $70 $80 $90 $100 $110 $120 $130
Own 100 shares and sell the 110 call for $189. The chart shows the profit per contract at expiration for each stock price. The dot marks the break-even price.

Your largest gain is $1,189: $1,000 from the stock and $189 from the call. That is 11.9% in 90 days. Your break-even is $98.11, because the premium covers the first $1.89 of a fall.

The cost is the gain above $110. Above $111.89, the stock alone does better. In a large fall, the covered call loses almost as much as the stock.

The cash-secured put

You sell one 95 put and receive $241. You keep $9,500 in cash, which is enough to buy the shares if you are assigned. If the stock ends below $95, you buy 100 shares at $95.

Sell the 95 put for $241 and hold $9,500 in cash. -$3,000 -$2,000 -$1,000 $0 today $100 $92.59 $70 $80 $90 $100 $110 $120 $130
Sell the 95 put for $241 and hold $9,500 in cash. The chart shows the profit per contract at expiration for each stock price. The dot marks the break-even price.

Your net price for the shares is then $92.59, which is the strike minus the premium. If the stock ends above $95, you keep the $241 and buy nothing. The model gives a profit in 74% of cases.

Stock at expirationStock aloneCovered call (110)Cash-secured put (95)
$70-$3,000-$2,811-$2,259
$80-$2,000-$1,811-$1,259
$90-$1,000-$811-$259
$95-$500-$311+$241
$100$0+$189+$241
$105+$500+$689+$241
$110+$1,000+$1,189+$241
$120+$2,000+$1,189+$241
$130+$3,000+$1,189+$241

Two names for one shape

Compare a covered call and a short put at the same strike. The next table uses a strike of $100 for both. At every stock price, the covered call makes $98 more than the short put.

Stock at expirationCovered call at 100Short put at 100Difference
$70-$2,457-$2,555+$98
$80-$1,457-$1,555+$98
$90-$457-$555+$98
$95+$43-$55+$98
$100+$543+$445+$98
$105+$543+$445+$98
$110+$543+$445+$98
$120+$543+$445+$98
$130+$543+$445+$98

The $98 is about the interest on $10,000 for 90 days at 4%, which is $98.15. The covered call ties up $10,000 in stock. The short put leaves the cash in the bank, where it earns that interest. Apart from the interest, the two trades are the same.

Put-call parity, from lesson 3, is the reason. So one of the two trades is not safer than the other. Choose between them on cost and convenience.

Key points

  • A covered call gives up the gain above the strike in return for cash now.
  • A cash-secured put pays you to wait for a lower purchase price.
  • At the same strike, the two trades have the same risk.

Sources

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