What I enjoy most about being an OP contributor is having the opportunity to help OP subscribers become better traders--to explain the nuances of options that allow readers to make better trading decisions for themselves. To help you be self-reliant. It's like the old parable: "Give a man a fish he eats for a day; teach a man to fish, he sits in a boat and drinks all day." Wait. I mean "...teach a man to fish you feed him for a lifetime." Yes. That's the one that's more appropriate here. I am truly honored to have the opportunity to teach fellow traders to fish.
Today Skip Raschke wrote a fantastic article discussing two option strategies--covered calls and naked puts--pointing out that they are synthetically identical. Concepts like this are so important to learn and can make traders much more successful once they grasp them.
But the spirit moved me today to follow up on Skip's article as a result of a reader's comment to Skip's article. I wanted to take the opportunity to help clarify why a covered call is synthetically identical to a naked put.
To best understand, consider what happens at expiration to the stock options in each of the two strategies.
Stock above the strike price at expiration: The call is assigned and the stock is consequently sold. Maximum profit is reached and there is no resulting position in the stock.
Stock below the strike price at expiration: The call expires and the trader retains possession of stock. The trader assumes the risk of stock ownership, which could possibly lead to a substantial loss should the stock fall precipitously.
Stock above the strike price at expiration: The put expires. The trader achieves maximum profit potential and there is no resulting position in the stock.
Stock below the strike price at expiration: The put is assigned and the trader gains possession of stock. The trader assumes the risk of stock ownership, which could possibly lead to a substantial loss should the stock fall precipitously.
The end game is the same in both strategies: no stock position and max gain if the stock is above the strike at expiration; or owning stock with all the risk implications that come along with it if the stock is below the strike at expiration.
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Dan Passarelli can be followed on Twitter at twitter.com/Dan_Passarelli.