Sunday, May 9, 2010

Diagonal vs. Covered Call

I watched a video yesterday on Diagonals and saw the example of how its similar to, and therefore often an alternative to, writing a covered call. Instead of owning the stock long and selling a call for a traditional covered call, you buy an ITM call instead of being purely long the stock and still sell a covered call. The risk/reward trade off is you're paying some time premium for the ITM call, but limiting your downside risk to the debit paid for it as opposed to having potentially unlimited risk down to 0 of owning a stock.

There is another trade off to think about though if the stock pays a dividend as you wouldn't receive this owning an ITM call. I'm going to look at a covered call I'm interested in today and then put both that and a diagonal on in the paper trade account so I can follow along. I know I've talked about using real money even if it's only 1 contract to kind of force yourself along to learn, but I think going forward there is going to be several types of new ideas I want to try out and I don't want to use real money for all of them as I would expect to lose as I'm learning. If I can figure out how to use the ThinkBack function on TOS then I can maybe backtrack a recent covered call I closed out on (MO) to see how a calendar might have worked out instead. This learning process is going to be long and slow as it takes time for some things to sink in to the point where I'm very comfortable deciding what to use in certain situations. So I think I'll just continue to do what I have experience with and add new things as I feel comfortable. I'll post an analysis on this Diagonal vs Covered Call trade off after I think I have a solid handle on it.

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