An Options Education

[Harry4358]

Hi,

I was hoping someone could give me some insight in the trading of options on the UK markets, specifically cover calls.

I am currently doing an internship with a education company based in India which teaches individual traders, typically aspiring middle class who are looking to start trading.

The company teaches traders to collect on their stocks through covered calls and puts. It seems like a simple strategy, with relatively simple technical analysis involved to identify entry points, and good returns with an extra 10-15% annualised.

Why does it seem to become far more complex when I try to translate this method to the UK markets. I have read other threads where people tell prospective traders to steer clear of options.

What are the real risks of Covered Calls? Surely it reduces losses in bearish markets, and caps profit in a bullish market.

Thank You for the knowledge.

 

[Martinghoul]

What do you mean "what are the real risks of covered calls"? You're synthetically short a put and that's the risk...

 

[Harry4358]

What do you mean "what are the real risks of covered calls"? You're synthetically short a put and that's the risk...

Well I suppose I am asking for a worst case scenario. My thinking is when considering a Covered Call, the worst case scenario would be that the stock enters a bearish trend and losses value, which outways the premium collected when selling a covered call.

Though you still have cushioned the loss compared to leaving the stock to its own devices.

If it is this simple. Why are options considered such a hard investment instrument? To me it seems like an effective and simple tool.

 

[Martinghoul]

Well I suppose I am asking for a worst case scenario. My thinking is when considering a Covered Call, the worst case scenario would be that the stock enters a bearish trend and losses value, which outways the premium collected when selling a covered call.

Though you still have cushioned the loss compared to leaving the stock to its own devices.

If it is this simple. Why are options considered such a hard investment instrument? To me it seems like an effective and simple tool.

Yes, you have cushioned the loss, but what's the cost of having such a cushion? You've sacrificed all the upside you could have.

The reason why options are considered harder is because you have a lot more degrees of freedom when pricing them. Also, the payoff of a portfolio that contains options is non-linear and that's always more complicated than straightforward linear.

 

[Esta]

But your bet is capt to the option price,isn,t it?
It seems to me like a pure bet, i bet 1000 dollar and if my predicted trend was wrong i lose all my bet. If it was right i win my gain with leverage. All right?
Sorry for my bad english. I'm italian guy whom learn it by myself, if you want correct me it's a pleasure for my side.

 

[Martinghoul]

But your bet is capt to the option price,isn,t it?
It seems to me like a pure bet, i bet 1000 dollar and if my predicted trend was wrong i lose all my bet. If it was right i win my gain with leverage. All right?
Sorry for my bad english. I'm italian guy whom learn it by myself, if you want correct me it's a pleasure for my side.

No, like I said, covered calls are equivalent to being short puts. Your downside is unlimited, while your upside is capped.

 

[Esta]

Why? Isn't an option? (I mean, i can choose if exercise it or don't)?

 

[Martinghoul]

Why? Isn't an option? (I mean, i can choose if exercise it or don't)?

A covered call strategy means you're short an option. When you're short an option, you don't get to choose.

 

[Esta]

So the only benefit is the price of the option that the buyer pay to us...?
Ok, it's look to me too dangerous.

 

[Martinghoul]

It's just like being short a put... People sometimes use these strategies to "buy" the underlying at a price they like.