Do you feel compelled to earn more than the maximum?

One of the tenets of my investing philosophy is that it's a good idea to be satisfied when the maximum possible profit – for a given trade – is achieved. 

All the option strategies I recommend come with limited profit potential.  To me, that's the cost associated with reducing, or severely limiting potential loss.  I like that trade-off.

Not everyone feels that way.  Some want to exceed the maximum possible result, and search for ways to adjust the original trade to allow for additional profits.  The risk of taking that action is always ignored.

I've corresponded with a collar owner and a covered call writer who are looking for advice on how (and when) to change their positions so they can earn 'more coin.'

Here's an example:

Covered call:

Buy  500 shares of PIG @ $46

Sell  5 PIG Dec 50 calls @ $1.50

Maximum profit $550, if assigned an exercise notice ($400 profit on stock, plus option premium)


Same example, but add:

Buy 5 PIG Dec 45 puts @ $2.50

Now the maximum profit is reduced by the cost of the put and is only $150

When the stock, aptly named for these traders, moves beyond 50 (the strike price of the call they sold), they become obsessed over earning more money on the trade.

The answer is not difficult.  The method is to repurchase the Dec 50 call and find another, suitable call to sell.  That new call has a higher strike price.  There's more involved, but the point of this discussion is not how to solve that problem. 

The fact that neither trader was pleased when the stock ran through the strike price and each was interested in foregoing the profit already earned in an effort to earn even more.

I am not against the idea of letting profits run, if that's your style.  Nor am I against the idea of trying to earn an extraordinary gain from a trade.  But, when you adopt a strategy with a limited profit, and you earn that profit, I believe the investor should be satisfied.

Not everyone has to agree, but that's the philosophy that works for me.

So, the question is:  Is there a solution to this dilemma?  Is there a way to encourage traders to recognize that they made a good trade, have an outstanding result, and ought to walk away a happy winner, and not an unsatisfied winner?

If you have a good reason for seeking extra rewards from a position, there is nothing wrong with that.  This post is for individuals who cannot resist temptation.   It's not that they truly believe the stock is going higher or that they want to get more bullish.  The suggestion made below is intended for those who lack the discipline to accept their good fortune.  They feel compelled to seek the possibility of selling their stock at the top possible price.

I believe there is a simple solution that eliminates the need to take the risk of seeking extra profits.  There is just something about being short a call option that has moved into the money that convinces the trader he/she made a mistake, and shouldn't have sold the call.

The simple alternative.  Trade the equivalent position.

Instead of the covered call, sell the equivalent cash-secured naked put.

Instead of the collar, sell the equivalent put spread.


Naked put replaces the covered call:

Sell 5 PIG Dec 50 puts

Put spread replaces the collar:

Sell 5 PIG Dec 50 puts

Buy 5 PIG Dec 45 puts

Let's look at this from the point of view of the trader.  When the stock rallies, the position continues to earn more money as the Dec 50 put shrinks in price.  There is no compelling urge to buy that put and replace it with another put at a higher strike price.

As the stock continues to rise, the investor smiles as the put premium erodes. 

The profit potential is the same with the original spread or it's synthetic equivalent.

When short the call that is continuing to increase in value, the trader can become upset.  When short the put that continues to move farther out of the money, the trader is satisfied.

It's the equivalent position.  It's the same profit.  It just looks and feels different to the trader who does not recognize that it's okay to be short an ITM call when it's covered.  Choosing the equivalent trade just makes it psychologically easier for some traders.

If you are one of these traders, do yourself a favor and adopt the simpler put strategy instead of the covered call or collar.


7 Responses to Do you feel compelled to earn more than the maximum?

  1. semuren 11/17/2009 at 7:34 AM #

    Greetings Mark:
    PIG, I guess you could have used HOG, but that is a real stock and maybe some would have taken it as a trade recommendation.
    I think the point you make is very interesting. Or perhaps I should say that one of the points one can take away from you commentary is very interesting. That is, despite the trades being equivalent in greeks and PnL terms people think of them as being very different. Covered calls are for the “conservative investor” and put sales are for risk addicted gamblers. On the one hand this cognitive disconnect from a fully rational analysis reminded me very much of behavioral fiance research. But on the other, I think there is a reason why people think of the risk in covered calls and short (cash covered) puts as different: because people trade them differently. This point was made in a post on naked puts vs. put spreads on the Elite Trader board. (It was very long thread [sorry I don’t know the link] and you were one of the participants.)
    If we take the PIG example above what the discussion participant pointed out was that most people who would buy PIG at 46 and sell the 50 call would not sell the 50 put. And, most put sellers, again with PIG at 46, would not choose to sell the 50 strike. I suppose one should add that most covered call traders would not buy PIG at 46 and then sell the 40 strike (I think some WOULD sell the 45, but not most). If there is a patterned way in which strike choice differs from covered call traders to put sellers then the PnL and greeks of the trades will differ too. Again I think this might be thought of as “cultural” difference between how most traders view these two types of trades.
    Well, that sort of got off the subject, but I hope it might be of interest/help to some.
    On a related topic I was listening to Larry MacMillian on a Think or Swim chat form some weeks ago. He suggested using a ratio put spread trade. (For example PIG is at, yes, 46. Buy one 45 put, sell one 42.5 put and one 40 put.) This spread, while long delta is actually a mildly bearish play. It should be put on for a credit and the trader has the advantage of selling higher IV than s/he buys (the skew means that the two short puts, in equity products, should usually have higher IV than the long). One can also see this trade as a combination of a short bear put spread and a short put. And there is a related post on Tlyer’s Trading ( ). If the underlying does not plunge below the short strike of the lower put one should be able to let this spread expire for the small credit that one got when putting it one. Or, if, over time the underlying drifts into the area between the two short strikes one may be able to take the spread off for second credit. MacMillian recommended using the S&P 500 futures options for this trade and managing it by simply taking the loss and taking the position off it the underlying goes through the lower short strike.
    I know that you (mostly?) advocate not selling puts on underlyings one does not want to own. So I can guess that your thoughts about this strategy are negative, but I thought I would ask anyway (Thus, what do you think of the strategy?). Also, do you see any other options for managing the trade?
    And, as if this comment were already not too long and winding, I will ask a little more about put selling. Here ( is a very interesting post on the CXO Advisory Group blog on a paper on selling puts on the S&P 500 futures options. There is also a link to further, critical, discussion of that paper there. CXO seems to think that the naked put selling strategy looks quite good (when positions size is properly controlled) and they have set up strategy test using it ( So my question here is do you think a strategy of selling a (reasonably sized in account % terms) puts and/or ratio put spreads makes sense in light of the arguments presented above and in the links cited? And, would taking the underlying on assignment and selling calls against it be a good potential follow up strategy? Any thoughts you might have time to post on this topic would be much appreciated.
    As always, thanks for the blog, the Rookie’s book (I have not read the others or I would say thinks for those too) and your other work on options education.

  2. Mark Wolfinger 11/17/2009 at 9:02 AM #

    1) I try to be careful with stock symbols when choosing a fictitious trade.
    2) I agree. There is no doubt that investors perceive a covered call and naked put as being very different trades. One of the reasons for this is that their brokers have different requirements when allowing a customer to use one strategy or the other.
    BTW, I am one of those who would elect to write the 45 call, rather than the 50 call.
    3) Regarding cultural differences: People who don’t fully understand the principle of equivalence prefer to sell OTM options. That holds true for call writers and put sellers. The goal is to see the options expire worthless, and OTM options provide a much better opportunity for the writer to achieve that goal. The profit potential for the trade is ignored because ‘expiring worthless’ is the goal, and ‘being assigned an exercise notice’ is an unwanted event.
    There is no rational reason why this is true, and I attribute it to a psychological need to ‘win.’ Selling an option, collecting a premium, and having it expire worthless appears to be considered to be a ‘win’ and achieving the identical profit when assigned an exercise notice is just not as satisfying.
    4) Regarding McMillan’s idea; I always referred to that strategy (buy one, sell one, sell one) as a ‘Christmas tree.’ As with all strategies there is a magic area in which profits are maximized. Any spread in which more options are sold than bought has a ‘best’ price at expiration. And that’s fine for traders who want to take a stance on how far the stock will move.
    I prefer not to go for that extra profit and thus, avoid selling extra, naked short, options. I have no specific objection to that idea, but it does add additional risk and reward. This trade is very attractive to many – and for good reason. But, because my audience can include many beginners, I don’t want to include strategies with open-ended losses. Yes, covered call writing (and naked put selling) are the exceptions, but my rationale for that is: these are introductory, educational strategies. Once learned the trader can decide whether to move on to less risky methods, or stay with the more risky strategy.
    5) There are always several alternatives for risk management. But, the idea of exiting, taking the loss, and finding a better trade is effective and easy.
    6) Put selling. Brief reply – I did not take time now to read references. Yes, it’s a decent idea – for the investor, not for the trader. Yes, I believe the overall returns are good – bear markets notwithstanding. This is equivalent to writing covered calls, and the CBOE Buy-Write index, BXM, shows outperformance over the past 21 years.
    Ratio spreads really depend on how risk is managed on which options are sold. But it is viable. Yes, writing covered calls works as a follow up strategy. It’s the same strategy continued at lower stock prices.
    To be honest, the Rookie’s Guide replaces both earlier books, so there is no need to read them.

  3. Tyler 11/17/2009 at 9:27 AM #

    Hey Mark,
    Great discussion. Though I’ve seen many discussions regarding covered calls vs. selling naked puts, I’ve yet to see it explained this way. This definitely helps shed insight on the psychological aspect of choosing one equivalent position over another.
    Well done-

  4. Mark Wolfinger 11/17/2009 at 10:05 AM #

    Amazing, isn’t it.
    Same trade; it just looks different. And investors believe it’s different.

  5. Brad 11/17/2009 at 12:25 PM #

    Hi Mark,
    An admittedly piggish thought has been tossed around my head for a few weeks now, but I have yet to implement it. Once the trader has extracted about 70-80% of the time premium in their IC and expiration is nearing (say 4/5 weeks) I thought about buying a butterfly on either side of the market price of the underlying. Or alternatively selling a smaller (stike price-wise) IC inside of the original position. The thought process is that if there is still a small amount of volatility in the underlying, then the price should swing one way or the other (but hopefully not too far) into one of the fly profit zones or stay withing the short strikes on the new IC.
    I want to make more on the trades because I generally write ICs with a high risk/reward ratio as high a 3 or 4 to 1. Maybe I should just write lower risk/reward ICs but they make me a little nervous. I know I’m trying to be a pig here, but wanted to get some feedback from a risk-oriented individual like yourself.
    Underlying SPY @ 111.05
    IC: Dec 93,95,119,121 @ 0.45 Credit (older position)
    Flys: Dec 107,109,111 & 112,114,116
    Small IC: Dec 106,107,116,117 @ 0.42 Credit

  6. Dom 11/17/2009 at 12:55 PM #

    Mark…Ii want to share my experience with you and the readers: I hate covered calls but I know why they are used as compared to naked put selling- The naked put seems as if a worst case scenario would wipe you out, while a covered call seems as if you would retain some of the equity…Not true, but when you are beginning it seems to be true… also you wrote
    ” But, because my audience can include many beginners, I don’t want to include strategies with open-ended losses. Yes, covered call writing (and naked put selling) are the exceptions, but my rationale for that is: these are introductory, educational strategies. Once learned the trader can decide whether to move on to less risky methods, or stay with the more risky strategy.
    As a not so beginner but one recently I would avoid the covered call/Naked puts at all costs- Unless is was written on some very stable stocks…Why? any gap down overnight or intra day is uncontrollable as you say options are about managing risk and yet this completely removes the structure to control risk…We don’t have to look very far to see the different companies that this has already happened with.
    I much prefer to have both a defined risk/reward and worst case scenarios in advance, with adjustments already reviewed for applicability and usefulness.
    Thanks, Don

  7. Mark Wolfinger 11/17/2009 at 2:53 PM #

    I agree that limited risk and reward is the right combination for options.
    But the majority of people are long, always have been long, and will remain long until the day they die.
    That’s not for me. But for those investors, writing covered calls beats buy and hold – despite the fact that professional advisors and planners fail to comprehend.
    Thus, I encourge this strategy for long investors who currently waste money on fees paid to those advisors.