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Maximizing Profits: Naked Calls vs. Covered Calls

Brandon Ly

🔥 If you're looking for a way to earn extra income, selling call options can be a powerful strategy. But beware: selling naked calls can be risky. Here's what you need to know.

Naked Calls
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💰 Selling call options gives you the ability to earn premium income. But if you sell a naked (unhedged) call, you're taking on unlimited risk since you're obligated to sell the underlying asset at a preferential price if the buyer exercises the option.

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Covered Calls
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🤔 So what's the alternative? You can sell covered calls, which involves selling call options on an asset you already own. In TradFi, this is considered "safer" since:

  • Downside is NOT unlimited (but still substantial)
  • Markets tend to go up (this is a bullish strategy)

The payoff of selling a covered call is the same as a naked put. (Bonus point: covered call = naked put = Uniswap LP 🤯)

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Backtest Strategy
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🔍 To figure out which strategy is right for you, it's important to backtest and analyze past data. Let's analyze what periodically selling naked ATM ETH calls over the last 2 years might look like!

Anyone will be able to sell options on Panoptic for any asset at any strike. Panoptic options even have an "effective Time To Expiration"👇 This means you can customize your Panoption to sell "dailies", "weeklies", and "monthlies". Let's backtest these 3 strategies!

Backtest #1: Selling (naked) calls on ETH every week
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  • Earned 126% in premia
  • Lost 132% from calls being exercised

→ Total PnL: -6%

(Compare to ETH HODL: -32%)

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Unfortunately, our strategy wasn't profitable. What if we tried different rebalancing periods?

Backtest #2: Selling (naked) calls on ETH every day/week/month
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  • Weeklies: -6%
  • Monthlies: -28%
  • Dailies: -57%

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Wow...dailies & monthlies did even worse. Let's try something typically seen as "less risky" — covered calls!

Backtest #3: Naked calls vs. covered calls
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  • Naked calls: -6%
  • Covered calls: +6%

(The fact that they are exactly opposite is a coincidence.)

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Covered calls did better...but why?

Notice how naked calls (blue curve) performed great in May 2022 — during the Terra collapse and bear market!

Fact:

  • Bull market → naked calls 👎
  • Bear market → naked calls 🚀

Let's test this out on one of the biggest bear markets: the UNI-ETH price!

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In the spot markets, UNI has massively underperformed ETH. That makes the UNI-ETH price a bear market. So what happens if you sell naked calls on UNI-ETH? Answer:

  • 😎 Dailies: +55%
  • 😄 Weeklies: +54%
  • 🙂 Monthlies: +38%

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Summary
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  • Naked calls have unlimited risk
  • Naked calls are bearish and do well in 🐻 markets
  • Covered calls are bullish and do well in 🐂 markets

Caveats:

  • ⛽ Ignores gas/swap fees/commission
  • 💲 Assumes premia = LP fees
  • ❓ This is hypothetical — you can't sell calls on Uniswap (Panoptic soon 🤫)

Disclaimer:

  • 📢 None of this should be taken as financial advice.
  • ⚠️ Past performance is no guarantee of future results!
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