No. of Recommendations: 1
<<Selling puts is very similar to covered calls, even though they may feel different psychologically.>>
Hmm, people always say that, armchair theorists, but I tend to disagree. The differences are huge in my view, having done rather a lot of both. The theory of equivalence, among other things, assumes you can borrow without limit and without margin calls at the risk free rate, and can earn it on your cash balances, and don't care about your cash balance, positive or negative. There are several other built in assumptions and small differences, but that alone should dispel the notion of true equivalence.
I don't quite understand what you mean by this. Can you explain?
I look at it this way. Let's say you want to enter this type of trade notionally of 1000 BRKB shares. You have two choices:
1) Buy 1000 shares of BRKB for about $500,000 and then sell, say, 10 March covered calls at strike 520 for about $6,000 (about $6.00 each).
or
2) Sell 10 March cash covered puts at strike 480 for about $6,000 (about $6 each) and retain $480,000 in your cash account to cover the possible exercise and assignment of those puts. The puts will decay in value while the $480,000 will earn interest (about 3.55% per annum right now).
If you don't have the $500,000 and need to use margin for the trade, wouldn't the amount of margin be about the same in both cases? And in fact, wouldn't the first case would probably cost a bit more because while they (the brokers) are giving you 3.55% on cash retained in your account, they charge more like 7% for margin used from your account? But if you aren't using margin, then they are very close to being equivalent trades.
In general, I much prefer the put selling to the covered call trade. I learned that from Warren Buffett ... it's better, always better, for YOU to hold the "collateral" (the cash in this case) than for the other party to hold it. Sure this is a minor point in the way we trade options via brokers and through market makers, but still ... to me I prefer having that $480,000 sitting in MY account rather than the other way around.
Also, the tax treatment of covered calls can be very different from short puts.
I don't see it. If I sell a cash covered put, even one two years out, and it expires worthless, that entire gain is considered to be a short-term gain and taxed at ordinary income tax rates. But the same applies to a covered call, when the covered call expires worthless, even two years out, that gain is also considered to be a short term gain and is taxed at ordinary income tax rates. Now, if the short put is exercised and assigned to you, then that value is subtracted from your basis and isn't taxed as short term gains, but instead will become a capital gain, and if held for a year plus will become a long term capital gain taxed at those preferred rates. And the same applies to the covered call if it is exercised and assigned to you (if you held the stock for a year plus, it is a long term gain/loss when the stock is disposed of via delivery to the option exerciser). So they are treated similarly as far as taxes go.
