Courtesy of Seeking Alpha’s “Reel Ken”

We often hear about selling covered calls to generate additional income. We also hear about selling Puts to generate income. So the question becomes: Which is a better strategy?

The first step in answering this question is to understand that, from a performance perspective, they are two sides of the same coin. That is, if you owned, say 100 shares of the SPDR S&P 500 ETF (SPY) and sold a covered call with a strike of, say $140, in theory you would get a similar result by simply selling a put option with a strike of $140. Reality is a little different.

Let’s look at why this is so. SPY is currently trading at $139.79. The January 2013 $140 strike call sells for $7.99. If SPY closed at or above $140, I would make 21 cents on SPY and $7.99 on the covered call for a total of $8.20. However, SPY pays a quarterly dividend averaging about 66 cents, and the SPY shares would earn this dividend. There are three dividend events (June, September and December) totaling $1.97. So my total return would be $10.17 ($7.99 + $0.21 + $1.97).

In contrast, the $140 strike put sells for a credit of $10.15. If SPY closes at or above $140, this total credit is earned profit and compares favorably to the $10.17 combined return from the covered call. So, the covered call and sold put are about equal.

If SPY closed below $140, the equivalence stays intact, but I’ll leave it to the reader to do the math.

What about other option expiration dates? Continue reading →