Covered Call Vs Naked Put (With CBOE Data)

Online "gurus" selling paid courses touted covered call as a "secret" way to generate income with claims like this. 

  • If you sell a covered call and hold onto it, you have a 100 percent chance of making money on that trade.

That is not true and covered call is quite similar to naked put in term of the limited upside and downsides which I will share.

Differences between Covered Call vs Naked Put

  • Performance of Naked puts index (PUT) is better than covered calls (BXM)  based on CBOE indexes started in 1986. As of 21 Oct 2020, CBOE PUT index is 36% higher than CBOE BMX (1881.89  vs at 1380.15)
  • A covered call requires stock ownership vs naked put
  • A covered call requires more commissions since 2 trades are involved vs naked put
  • A covered put allows more flexibility when the price is against you vs naked put.
  • A covered put does not require margin vs naked put

Covered Calls vs Naked Puts with Data

I managed to find this a CBOE Research named "An Analysis of Index Option Writing for Liquid Enhanced Risk-Adjusted Returns" which best explained covered calls and naked puts with some historical numbers.

It is a short read so do read the research if you are interested more in options.

1. Theoretical Risk-Reward of Covered Calls vs Naked Puts Options

Firstly, the theoretical risk reward of naked puts and covered calls are the same (see the purple line which is for PutWrite - i.e. naked puts and BuyWrite i.e. covered calls) for their respective options. 

2. Historical Performance of Covered Calls vs Naked Puts Options

However, you will see the performance of naked put (PUT) is much higher than covered calls (BXM). $12.53/$9.30 = 35% better.

Why is naked puts performing better since 1986? As mentioned, a covered call requires you to have stock ownership vs naked put which do not.

The main reasons I felt that a naked put done much better during the earlier years was because the remaining money was placed in T-Bills based on CBOE which was a good hedge at that time vs stock market crash. 

Even between 2001 to 2011, performance of Covered Calls only beat Naked Puts Options in 2002 (losing 7.6% vs 8.6% lost by PUT). As long as there is sufficient interest rates in T-Bill (i.e. not negative interest), I think PUT might keep doing better.

However, as an investor, you do not need to put your money in T-Bills. You could put in other hedges like Bitcoin or even your saving accounts.   

3. Margin Requirement for Covered Calls vs Naked Puts Options

A covered call does not require margin since you already own the stock to cover the risk. However a naked put require proper planning in your margin. Given how I got my options force sold once because I didn't know how margin worked in the start, you have to be extra careful with naked puts.

4. Commission for Covered Calls vs Naked Puts Options

Because a covered call requires 2 trades, it requires more commissions compared to a naked put usually. I doubted CBOE accounted for commissions in their trades so it might lead to a wider differences. (don't underestimate the effect of commission, that is how big brokerage films are still in the money besides selling your trades information in RobinHood case).

5. Risk of Covered Calls vs Naked Puts Options

Both covered calls and naked puts are risky and give you limited profit which sounds ridiculous for a normal stock investor. Why would you want to limit your upside? You would go for naked puts and covered calls when

  1. Want to generate more income at a much higher risks
  2. The stock price have limited upside during the period (e.g. sales is as expected without any downside or major upside)
  3. The option IV is higher than normal (generally you sell options when IV is high and buy options when IV is low).

Other Sources Of Opinions

Some other resources if you are interested to read other opinions:

  • Naked Put Defintion (investopedia.com) - A naked put is an options strategy in which the investor writes (sells) put options without holding a short position in the underlying security.
  • Covered Call vs. Regular Call: What's the Difference? (investopedia.com) - A covered call is an options strategy that consists of selling a call option while a regular call is where an investor sells a call option.
  • 5 Ways To Compare Naked Puts And Covered Calls (cboe.com) - Everyone has heard that writing naked or uncovered options is extremely high risk. This is not necessarily true. The covered call is risky because a stock's value can fall below the net basis.
  • Covered Calls vs. Naked Puts - TheStreet (thestreet.com) - I want to follow up on fellow OptionsProfits contributor Skip Raschke's article and help clarify why a covered call is synthetically identical to a naked put.
  • Selling Puts vs. Covered Calls (investorplace.com) - Covered Calls vs. Naked Puts - Many investors are surprised to learn that the benefits of covered calls can be had without increasing risk by selling short or naked puts.
  • Covered call vs naked put in online brokerages - Personal Finance ... (money.stackexchange.com) - If a covered call has same risk profile as naked put, how come brokers allow covered call but only allow naked puts to experienced traders?
Author
Sky Hoon. Read Full Bio
Website Owner, Twitter-er
He has been trading since 2008. He started this blog to share the journey about option trading. He dabbled in stocks, bitcoin, ethereum (in Celsius Network), ETF (lazy Dollar Cost Averaging) and also built websites for fun. He used this as a platform to share my experiences and mistakes in trading, especially options which I just picked up.

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