Quick quiz hot shot, manage a lot risky: 1) Selling naked puts, or 2) buying stock and selling calls against that position (buy-write strategy)? Many of the answer to this is number 1, selling naked puts. Well in this situation the typical response is even the wrong answer. Theoretically a naked put sale in addition to a buy-write are critically the same. Nevertheless this is easily illustrated and understood by simply via relationship between puts and calls inside put-call parity formula, which within the most simplest terms means: c = S-K+p, where c=call price, S=stock price, K=strike price, and p=put price.
One way to consider relationship from a naked put sale along with buy-write method to visualize the profit/loss payout of every structure. On the naked put sale scenario a trader sales a put and is particularly thus obligated to order shares at the strike price if the share price fall below the strike plus the trader is assigned. If shares do not ever move underneath the strike price the foremost the naked put sale position can generate is capped with the amount the trader collected from the inception of the trade. Thus the payout diagram shows a position losing (like stock) as shares decline in price and staying flat (along the premium collected) as shares move higher.
Inside buy-write scenario, a trader buys the root asset (stock) and sells a trip with the same strike price like for example the naked put sale scenario. Precisely this seem like from your profit and loss perspective? Well to start with the trader is actually a long shareholder therefore realize the job loses and gains with stock movement. However by selling the letter, the upside is capped at the strike price in addition to the premium collected…hmmm heard this before.
These 2 positions, the naked put sale and also buy-write are fundamentally the same, but many people tend to think the naked put sale is more risky. So far we’ve been focusing on comparing both of them strategies in a theoretical standpoint, however, in practice there are various Things to like about going the naked put sale route with the buy-write.
1) Lower transaction costs: This is as simple as it gets. Selling 1 naked put is one transaction, whereas buying stock and selling an unscheduled visit against it truly is 2 transactions. Thus, in reality, traders is paying twice the transaction fees below the buy-write scenario.
2) Lower Capital Commitment: Buying stock, which may really should be carried out in the buy-write scenario takes a more achieable capital commitment than selling naked puts which will require margin collateral which might probably be a lower amount rrn comparison to the kids stock.
3) Higher Volatility in Puts vs. Calls: An essential assumption within put-call parity is the fact that implied volatility of puts and calls is equivalent. Instead, what we know in practice might be that the implied volatility of puts is many times as compared to those of calls thereby a trader can expect to capture more premium in a put sale vs. a trip sale.
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