Don’t Sell Naked CallsWant to sell naked calls? When you have some success in the stock market you may start to think about other option strategies which can potentially increase your return. And while you’re at it why not look for the riskiest strategy ever, naked options. The problem with naked options is that they have so much risk. For instance if you sell the $30 call on a stock you have the obligation to sell the stock at $30. Theoretically your potential loss in infinite, because if the stock goes up to infinity you have to buy it at infinity and sell it at $30.Now I’ve never seen a stock go up to infinity before, but it could always go up to $60 or $120. Even though the odds of success are so high it only takes 1 major loss to completely destroy your account. What About Stop Losses What about using stop losses on naked calls? You can easily say if the stock gets to a certain point to just get me out of the trade and limit my loss. The problem with this is that stocks gap. Believe me I’ve experimented with naked calls before, when stocks gap you have an unbelievable opportunity to lose money, even with a stop loss! And like I said before it only takes one bad trade. ETF ETFs are pretty alluring because they tend not to be as volatile. So created a Naked ETF Naked call trading plan may seem like a good idea, but ETFs gap too, don’t believe me check out any major ETF and look at their past movements. Each huge upward gap could potentially lose you a lot of money. Covering Options Now I have nothing against option selling. In fact it is my favorite strategy, but if you are going to do it you have to do it right. By covering up options you limit your risk and increase your odds of success. There are basically two ways to cover a call. You can start covered call writing. where you go out and buy the stock before you sell a call on it. This way if you are forced to sell the stock you can simply use the one you already bought instead of having to buy it at an overinflated price. The second option is to buy another call option, so if you sold the $30 call for $5 and bought the $35 call for $3 you may lower your profit, but you also lower your risk. Now the highest price you could buy the stock for would be $35 rather than infinity. That makes a big difference. Still Not Convinced? Still not convinced that it is a bad idea to sell naked calls? That is fine; you do make the final decision when deciding how to invest your money. But just be warned that taking on an infinite risk will most likely not turn out very well in the long term. |
