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2003issue C011-2

Covered-call versus diagonal housing after a single-name drawdown

The same short-call income idea is housed two ways after roughly a 90 percent decline from 2000 highs, with cash prices near yearly lows and option volatility near yearly highs. A covered-call sits on shares. A diagonal-call-spread sits on a longer-dated in-the-money call. The comparison is remaining debit, leftover upside after the front month expires, and the path when the stock goes nowhere.

  • A covered-call buys the shares and sells a call so collected premium lowers net debit and the expiration breakeven versus holding the stock alone.
  • The same bullish-to-neutral view can sit in a diagonal-call-spread that uses a longer-dated in-the-money call as a synthetic-share-substitute.
  • The case study states worst-case outlay of 850 on the diagonal against 3800 on the stock-plus-call book, which still treats the remaining debit as capital that can be lost to a zero stock price.
  • Front-month-decay can still help the diagonal if the stock sits still for a month or two, and leftover upside remains on the long call after the near-term short expires.
Entries in this reading3 entries
Current trackCovered call writing31 readingsOption income strategy43 readingsOption spread61 readings

A post-drawdown setting

The reader’s setup placed the income idea after roughly a 90 percent decline from 2000 highs, with cash prices near yearly lows and option volatility near yearly highs.

The covered-call housing

A covered-call book is built by buying the underlying shares and selling calls against them. The collected premium is used for cost-basis-reduction. It lowers the net debit and the expiration breakeven relative to holding the stock alone.

The construction is presented for a bullish-to-neutral outlook that expects only a slow rise. The short call is kept inside 45 days so that time decay is meant to leave that option worthless.

In the worked example the stock trades at 40, 100 shares are purchased, and a December 40 call is sold for two points. That leaves a 3800 net debit after a 200 premium credit against a 4000 stock outlay. The remaining 3800 debit is still treated as capital that can be lost down to a zero stock price, even after the premium credit.

The diagonal-call-spread housing

The alternative houses the same view in a diagonal-call-spread. A longer-dated in-the-money long call is financed in part by a shorter-dated out-of-the-money short call. The illustration is a July 30 call with nine months against a December 40 call with two months, while the stock is at 40. The long call is the synthetic-share-substitute in that book.

The same case study states worst-case outlay on that diagonal as 850, compared with 3800 on the stock-plus-call book.

Stillness, leftover upside, and the two paths

Because the front-month short option is said to shed time value faster than the longer-dated long option, front-month-decay can still let the spread gain if the stock sits still for a month or two. Leftover upside remains on the long call after the near-term short expires.

On an advance the long call gains and the short call loses. On a decline the short call gains and the long call is described as losing mainly its time value.

How the payoff sketches are labeled

The covered-call payoff sketch labels a 2-point premium, a 38 breakeven, and a 40 strike. The comparison sketch labels a 30 long strike, a 38.50 breakeven, and a 40 short strike. Both diagrams are noted as excluding commissions and fees and as not to scale.

Educational research material, not investment advice. Historical source context does not establish present-day performance.
8 of 25 in the Covered call writing track
20031-3 pp.Next on Covered call writingCovered-call overlay on a stock portfolio as a payoff case studyAllocation across asset classes and diversification within a class are presented as first-pass exposure controls that can dampen swings but do not create an option-income stream.
All readings on this track · 25 readings
  1. 1995Sequenced covered-call repair after a growth-stock drawdown
  2. 1996Covered-call writing as income and assignment discipline
  3. 1997Relative volatility rank for covered-call overlays
  4. 1997Covered call time, probability, and implied volatility
  5. 1999Covered-call income when implied volatility is cheap
  6. 2000Covered-call income and assignment flexibility
  7. 2002Covered-call expiration rate versus expected value
  8. 2003Covered-call versus diagonal housing after a single-name drawdown
  9. 2003Covered-call overlay on a stock portfolio as a payoff case study
  10. 2003Ratio backspread and covered-call assignment construction
  11. 2004Covered-call income is not a safety net
  12. 2006Evaluating consecutive covered calls across market regimes
  13. 2007A job-first audit of commodity options in a futures book
  14. 2011Horizon checks on Covered call writing, the risk-reward ratio, and the Relative Strength Index
  15. 2012From ex-date verticals to leftover buy-writes, and a call backspread that stays net long
  16. 2013Year-long covered calls on high-yield industrials
  17. 2014Year-horizon covered calls on Dow yield ranks
  18. 2014Covered-call premium as a cost-basis cushion
  19. 2014Monthly buy-write construction with traffic-light exits
  20. 2017Low-volatility covered calls need a real premium buffer
  21. 2017Covered-call futures income as one testable procedure
  22. 2018Partial covered-call overlays at targets, resistance, and rich volatility
  23. 2019Weekly covered-call writing as a two-book credit-spread case
  24. 2019Weekly option income as one holding-period case
  25. 2019Locking long-call profit with a temporary overlay
By fieldOptions and volatility171 readingsBy year2003104 readings
All 31 readings tagged Covered call writing
Also on Covered call writing5 readings
2003Ratio backspread and covered-call assignment construction2019Weekly covered-call writing as a two-book credit-spread case2019Weekly option income as one holding-period case1995Sequenced covered-call repair after a growth-stock drawdown1996Covered-call writing as income and assignment discipline