KungFuPanda

prophets wrote:
it’s really not accurate to say writing covered calls provides downside protection.  maybe you say it lowers your implied cost basis, but having been on the floor of the CBOE, traded options for almost 20 years in my PA since i was a teenager, and worked at 3 different hedge funds where options were employed, it’s not appropriate to say it provides “downside protection”.  cuz it just doesn’t.  it’s an income generator and it lowers your cost basis.
100% correct. If you engage in a covered call you aren’t betting on the market going down (at least very much). You do it largely because you don’t think the market is going anywhere, and the call serves as additional income in the meantime.  If the market goes up you can close out the position.  
We’ve never used or thought of a covered call strategy as protection.

adehbone

Book seems to indicate otherwise.
selling a call + holding the underlying - is less risky than selling a naked call. By virtue of willingness to bear some risk - returns are also reduced. So a covered call by that definition has lower downside as well as lower upside.
Quote:
Pg 407-408
Because of the importance and widespread use of covered calls, it is worth- while to discuss this strategy briefly to dispel some misunderstandings. First of all, some investors who do not believe in using options fail to see that selling a call on a position in the underlying reduces the risk of that position. Options do not automatically increase risk. The option part of this strategy alone, viewed in iso- lation, seems an extremely risky strategy. We noted in Section 2.1.1 that selling a call without owning the stock exposes the investor to unlimited loss potential. But selling a covered call—adding a short call to a long position in a stock— reduces the overall risk. Thus, any investor who holds a stock cannot say he is too conservative to use options.
Following on that theme, however, one should also view selling a covered call as a strategy that reduces not only the risk but also the expected return compared with simply holding the underlying. Hence, one should not expect to make a lot of money writing calls on the underlying. It should be apparent that in fact the covered call writer could miss out on significant gains in a strong bull market. The compensation for this willingness to give up potential upside gains, however, is that in a bear market the losses on the underlying will be cushioned by the option premium.
It may be disconcerting to some investors to look at the profit profile of a covered call. The immediate response is to think that no one in their right mind would invest in a strategy that has significant downside risk but a limited upside. Just owning the underlying has significant downside risk, but at least there is an upside. But it is important to note that the visual depiction of the strategy, as in Exhibit 6, does not tell the whole story. It says nothing about the likelihood of certain outcomes occurring.

maxmeomeo

I got #43 wrong as well…my logic was:  if you buy the stock at $10 and it goes up to $50 and you sell a deep-ITM call at a $25 strike, and the price at expiration is $43, then you deliver the stock and receive $25 per share, which equates to a $15 gain plus the call premium (so effectively locking in a minimum value for the stock as long as the call you’re selling expires in the money and is above your desired gain).  However, this strategy completely blows up if the stock tanks and the call expires worthless - so in retrospect I no longer think that the covered call offers any actual downside protection.

Bad5shah

cpk123 wrote:
Book seems to indicate otherwise.
selling a call + holding the underlying - is less risky than selling a naked call. By virtue of willingness to bear some risk - returns are also reduced. So a covered call by that definition has lower downside as well as lower upside.
first of all almost anything is going to be less risky than selling naked calls or puts.  that’s just inherent in the contract.  if i write naked insurance policies on natural disasters it’s going to be a lot more risky than if i go out and get reinsurance from a major reinsurer like lloyds of london or berkshire to back up what i’m writing.
you can quote whatever crap you want from the book and hope that some academic trash reading from CFAI will approve of your viewpoint.  but CFAI even confuses volatility - a pricing component of the option premium with volatility of the stock price itself (movement of underlying).  it’s really a joke.  put that on top of the fact that CFAI has some hard-on for butterfly trades while completely ignoring strangles and other more common trades, makes it all the more comical.  it really is one of the worst written sections in all of the curriculum and any basic options book by james bittman or lawrence macmillan would put it to shame.
covered calls are an income generating tactic and help lower your cost basis.  plain and simple.  CFAI even have an EOC question with 4 people who have varying market outlooks and various strategies assigned, that verify this viewpoint.  market going nowhere and you want to generate some income?  write calls.

yuoska

I’m not as well versed as prophets in options trading (by reading his posts), but I have quite a bit of exposure, both on a personal level and a PM side.  He’s dead on.  I’ve heard of butterfuly trades, but have never implemented one.  Maybe others do, but straddles and strangles are very common.  Personally speaking, my “fun money” is usually employed in options trading, either through outright long put/call positions or straddles.  Covered calls, collars, protective puts - all commonly used in PM.

PieMan

diagram says it all boys and girls…ain’t much protection on the down side when you look at that bad boy

islandgyrl

They aren’t saying there is much, they are saying there is protection (even if it is minimal). On the test, merely say it has a minimal amount of protection on the downside in the free response section, or look to see if there is a better answer in the multiple choice section. Then move on. There are bigger fish to fry in the last 4 days of study.

koba

Poorly worded question imo. Covered call provides a small amount of downside protection equal to call premium, i.e. the stock could go down by x% and you won’t lose if the premium is x%.