Covering Naked Calls

You can cover your naked call by buying into the stock as it approaches the strike price. If you do this deftly, you then want the stock to be called away as you will make a gain on the sale of the stock. Buy 25 shares first, then leg into the remaining 75 shares as the stock price closes on the strike price.

If you want to be sure that the stock is called away, you can buy the last 25 shares when the stock price is far into the money — you take a small loss on those 25 shares but have gains on the purchase of the first 75 shares below the strike price. This strategy ensures that the stock will be called away — you don’t want to be stuck with 100 share of an overpriced stock.

The awkward situation is when you buy that first 25 shares below the strike price, but then the stock price reverses down hard — now you are stuck with 25 shares on a declining stock. If it declines far enough and hard enough, I start to think about a naked put, which would complete the strangle.

Not crazy about rolling the naked call to a higher and later strike price as you do this with a loss for the first naked call. Hedging by buying the stock means that you get to keep all of the original premium and can even make a small gain on the sale of the stock at the strike price to boot — a win/win. But you must have the cash reserve to do this.

The risk of hedging by buying the stock is that you may be stuck with 100 shares of an overpriced stock because it didn’t hold the strike price. But you have multiple options then. Just sell it immediately for probably a small gain. Sell an in-the-money call for some downside protection if you are bearish on the stock. Or sell another out of the money call if you are bullish on the stock. There are always options with options.

When the Music Stops

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