Options Forum: Return On Investment Redux

Because an at-the-money covered call, or buy-write position, has essentially the same risk/reward in dollar terms as shorting its related put, a look at its initial margin requirement dovetails nicely with lasts week's discussion of using return on investment as a tool for comparing positions with similar profiles.

The minimum initial requirement for a covered call is: 1) 50% of the stock price less the proceeds from the call sold, or 2) 30% of the strike price. So a buy-write position in Yahoo!, in which you buy shares and sell the January $30 call on a one-to-one basis, would require ($30 x 0.50)- $3.50 = $11.50, or $1,150 per 100 shares covered. (Again, because the latter formula results in just a $900 requirement, we apply the first formula.)

The maximum return on investment for this bullish position is 30%. You could also sell the January $30 put for $3.60, which would have an initial margin requirement of $960 a contract and a potential return on investment of 37%. Clearly in this example selling puts offers a better return on investment.

One thing to be aware of is that in stocks with options that sport very high implied volatilities, you'll find that the covered call can offer a better return on investment than selling the corresponding put. This is because the premiums collected from the call get subtracted from the initial margin requirements of a covered call, whereas the premium collected from selling short puts is added to the total margin calculation.

For example, with Sandisk(SNDK Quote) trading at $20.90, you could sell the January 2006 $20 put for $4.50, which has a margin requirement of $778 per contract and a potential yield of 57% for the 18-month period. Or you could sell the January 2006 $20 call for $6 against a long stock position, creating a covered call with a margin requirement of just $445, which would have a maximum return on investment of 114% over the same time period.