Covered Short Straddle
Covered Short Straddle is the most risky type of income strategy.
concept is to increase the yield of the Covered Call by selling a put at the same
strike as the sold call. In this way, we take in the additional income from the
sold put; however, there is a significant price to pay in terms of risk.
the sold put adds significant extra risk to the trade. The amount of potential
risk added is the put strike less the put premium received. Say if we trade a
Covered Call on a $24.00 stock, taking in $1.00 for the call, our risk and
breakeven is $23.00. If we sold a put for another $1.00, our initial yield on
cash would be doubled. . . but our risk would have increased by another $24.00
making our total risk $47.00 if the stock falls to zero.
this is unlikely to occur in just one month, the position can become
loss-making at approximately double the speed as a simple Covered Call position,
so if the stock starts to fall, we’re in trouble much more quickly.
with a Covered Short Straddle, we are almost certain to be exercised because we
have shorted both the put and the call at the same strike price. So unless the
stock is at the strike price at expiration, we face a certain exercise, which
many people are uncomfortable with. If the stock is above the strike at
expiration, then we are quite happy because our sold put expires worthless, our
sold call is exercised, and we simply deliver the stock we already own.
However, if the stock is below the strike at expiration, then our call expires
worthless, our sold put is exercised, and we are required to purchase more
stock at the strike price. With a falling stock, this can be pricey and
A rise is expected.
is a risky strategy, only to be used if you want to keep your underlying stock.
is trading at $28.20 on February 25, 2011.
the stock for $28.20.
the March 2011 30 strike for $2.60.
the March 2011 30 strike call for $0.90.
opportunity to earn income on the underlying stock if all goes well.
risk is the value of your stock plus the put strike price less the premiums you
receive for the call and put sold. This is a high risk strategy. The reward is
the generation of monthly income.
being generated on a monthly basis on the underlying stock.
downside potential with this strategy.
price minus half of the options premiums received plus half of the difference
between the strike price and the stock price.
Of Time Decay
Time decay erodes the value of the sold options.
stem a loss, sell the stock or sell the stock and buy back the call you sold. If
the put is exercised, you will have to buy back the stock at the put strike
the stock price falls under the put strike price, you will be exercised and
have to buy more stock at the put exercise price. The calls you sold expire
worthless. You keep the premium.
the stock price rises above the call strike price, you will be exercised and
make a profit.