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.
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.
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.
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 expiration | Stock alone | Covered 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 expiration | Covered call at 100 | Short put at 100 | Difference |
|---|---|---|---|
| $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
- Fischer Black and Myron Scholes, The Pricing of Options and Corporate Liabilities, Journal of Political Economy, 1973, for the model that gives every price in this course.
- SEC, Investor Bulletin: An Introduction to Options, for the definitions of calls, puts and assignment, and the 100-share contract.