Writing Naked Puts & Calls - Risks

[The Bear 10]

Can someone explain to me the main risks in this stock option activity? I have a friend and this is all he does. Is it any more dangerous then shorting something in the stock market overnight on huge margin, and having it gap against you hard way beyond your stop in the morning?

[wsam29 10]

in theory, unlimited risk and limited reward when you write naked options.

 

I used to do the same thing your friend does, but a coupe of close calls made me think twice. the risk involved for the reward is just not worth it.

 

Control the risk and the rewards take care of themselves.

[dalby 10]

actually, the risk is only technically unlimited when you write naked calls

 

the risk in writing naked puts is limited

[The Bear 10]

Yes, I don't understand him though. THis firend of mine. He has these pretty big losses. Last year he was down $25,000.00, and now he's been doing this naked options writing. Is this a logical move from the stock market?

 

I like the guy and don't want to see him get killed in the market. Could he? Do you have any advice I can repeat to him? I want to see him succeed.

 

His father has a $3,000,000.00 trading account...and he's been taking big hits...his losses seem to be getting bigger...$40,000.00 loss alone on the big drop day in the dow recently.

 

I keep repeating to him that he should lower his risk unit and just see if he can make money with small risk and small gains. Then slowly move higher. He made like $300,000.00 in 1 yr back in the NASDAQ boom days... but I'm scared that walll street will take it ALL back.

 

These markets today are difficult to trade.

[wsam29 10]

actually, the risk is only technically unlimited when you write naked calls

 

the risk in writing naked puts is limited

 

dude, until you actually write naked options you don't know what one goes through mentally.

 

In essence naked writers are not concerned about the risks invovled.

[wsam29 10]

Yes, I don't understand him though. THis firend of mine. He has these pretty big losses. Last year he was down $25,000.00, and now he's been doing this naked options writing. Is this a logical move from the stock market?

 

I like the guy and don't want to see him get killed in the market. Could he? Do you have any advice I can repeat to him? I want to see him succeed.

 

His father has a $3,000,000.00 trading account...and he's been taking big hits...his losses seem to be getting bigger...$40,000.00 loss alone on the big drop day in the dow recently.

 

I keep repeating to him that he should lower his risk unit and just see if he can make money with small risk and small gains. Then slowly move higher. He made like $300,000.00 in 1 yr back in the NASDAQ boom days... but I'm scared that walll street will take it ALL back.

 

These markets today are difficult to trade.

 

He'll either learn to stop doing what he's doing or he'll blow the account.

 

Its that simple.

 

Trading is a right of passage, just because your account is so big, does not mean you are capable of trading that amount of money.

 

I've been approached to manage money from a friend who has some solid connections in terms of network, in the millions, and I've still rejected his offer to manage money, we're talking maybe $10 million to start.

 

Its a totally different ball game when you have that much money.

[dalby 10]

d00d,

 

i have written naked PUTS. i would NEVER write naked calls

 

and as i said, the difference is that the risk is NOT unlimited in naked puts. basically, i write naked puts in my INVESTMENT account (not trading account) at a strike price where i would want to start accumulating the stock.

 

if i write naked puts with a 20 strike, and the stock is currently at 22, that means i would buy if i could get it at 22

a stock can only go to zero but it can go up (theoretically) infinitely.

 

so, naked calls DO have unlimited risk. naked puts do not.

 

it is incorrect to say that naked options in general have unlimited risk. that is only true of naked calls

[The Bear 10]

Guys I know in theory they have unlimited risk (naked calls), but is there any more risk than trading highly leveraged commodities short and having them gap against you the next day?

 

Yes in theory it is unlimited risk, but who would let a position move against them that much. Isn't it usually possible to close out these options positions?

[dalby 10]

bear,

 

first of all, unless you are talking about futures options, the options only trade during limited hours

 

so, there is tremendous overnight risk in naked calls

 

also, for many options, there is a lack of liquidity, especially when prices get volatile

 

there is more risk in naked options vs. shorting the stock in reference to the above example you gave (gap up overnight), because

 

1) the options trading time is shorter, so if the stock opens premarket with a gap and the gap turns into a runaway gap, you still have to wait for the optiosn to open to close your position (although you could hedge with some stock IF you have sufficient capital

 

2) calls increase in price based on both volatility AND price, whereas shorts only are affected by price.

 

theoretically, if u use similar size to what you would be shorting in stock (iow, if you would only short 100 shares of X, then only write one naked call), the risk is similar.

 

but it's still greater in naked calls.

[dalby 10]

btw, that was a typo in my above post.

 

should read "that means i would buy it at 20" (not 22)

 

btw, if you want to see how a trader can lose money with naked options, google "niederhoffer"

[Z_trade 10]

Well, I have to agree with what Woodie says - there no difference in trading futures/stock and sell naked options...

[dalby 10]

there IS a difference.

 

among other things, options price is affected by both volatility AND price.

 

underlying price is only affected by... wait for it... price

[The Bear 10]

You all have valid points....how about I just stay away from them. This friend of mine is urging me to start writing these. I told him I'm just going to stick with the commodity trading...since I can make money (net profit) at it.

 

Options sounds like a whole new game that I don't want to get into. I tried to read McMillans book, but it gets boring for me.

 

Dalby brought up one point though on liquidity....that alone though is enough to keep me away.

 

Curious, do any of you possibly know anything about options on Crude Oil (Symbol: LO). Is this a big market?

[dalby 10]

an example of the liquidity of options was one day last year when GOOG had a big selloff.

 

the MM's on the options were NOWHERE to be found. the spread was HUGE (much larger than the stock) such that people with calls would have to accept terrible price for fill and people with puts would get a much worse profit than they should have.

 

and that's on GOOG which is a very liquid stock, with lots of options activity.

 

i very much like writing naked puts. but that's an investment strategy not a trading strategy.

[The Bear 10]

That's pure shady business...how the market makers just disappear.

 

I once heard a guy say......

 

Options is a the Poor Man's Race Track. I wonder what that means. Are there more suckers in the options game? Since it's a zero sum game too, it can't be much different than futures right?

[dalby 10]

the reality is that most options expire worthless, so at least on its face, selling premium would be higher probability than buying it.

 

however, the loss is unlimited when you sell premium (with calls)

 

options are great. i love them. but they are more complex than futures cause you have to understand time premium, volatility, etc. iow a lot more than merely direction.

 

in futures, you only have to be right about direction to make $$$. in options, it's different. you can also have NO idea about direction, but be right about volatility and still make money.

 

options are much more flexible than futures, too

 

and if you are right, and you take the options position with the max profit, you can and will make a much larger return than you would with the equivalent futures position.

 

for new traders, i don't recommend options. i think getting a grasp on price action, which will help you in all markets, is the first step.

[TexasTrader 10]

If I may chime in . . .

 

I am an experienced options trader. A naked call or a naked put is a very directional "bet" that a stock/index/ETF will move a certain distance or not move a certain distance in a specified period of time.

 

I used to trade these especially just before expiration Friday. My thought process was what could go wrong in just a couple of days? As I found out, plenty can go wrong! I was once on the wrong side of a naked call and a separate naked put just before expiration and it cost me 10% of my account.

 

It is very easy to mitigate the risk of a single call or single put by buying a slightly different strike for the same expiration. This is called a credit spread. While the reward is much less, the risk is MUCH more manageable. Credit spreads (either a pair of calls or a pair of puts) are easy to learn and to trade. You can manage the risk to near zero by buying your sold strike when it gets cheap enough before expiration. I buy the sold strike for volatile underlyings (GOOG, AAPL, RIMM, etc.). I don't bother for more stable underlyings (SPY, SPX, DIA, QQQQ, etc.).

 

In sum, selling a naked call or a naked put is gambling. No amount of analysis will give guidance. If you like to live dangerously, play naked on biotechs just before an FDA announcement. Whoo hooo! Better than any roller coaster I've ever ridden. You won't sleep while you are sweating the outcomes.

 

Also, buying a call or a put with proper analysis and selling it for a profit can be a good income strategy. There are many ways to play this strategy. Buying ahead of earnings announcements and then selling just before or just after the actual announcement event can generate good returns!

[TexasTrader 10]

In response to the question about "LO", there is no LO symbol at the options brokerage I use (thinkorswim).

 

A good way to play crude oil (if you have the stomach for the volatility), is to write options against the OIH index (Oil Holders Index). It is a tracking index composed of companies with large crude oil interests.

 

Be careful about placing long term option trades on OIH though because it is so very volatile and seasonal and sensitive to supply/demand and to terrorism and . . . News events of many kinds move OIH rapidly up and down.

 

Here is an oldish link describing the OIH:

 

Oil Service HOLDR (OIH) -- In in-depth look at this oil stock ETF

 

Hope that is helpful.

[TexasTrader 10]

Posting messages late at night on forums is what I get for drinking a cappuccino with dinner!

 

The big advantage of trading options is leverage. You control much more stock with much less margin using options than you do by actually trading the underlyings.

 

Also, calls and puts can be combined in many creative ways. More complicated option trades can make money if the underlying goes up, down or sideways. As far as I know, you can't do that if you own a stock (with owning an equity, you are betting that it will go up; if you short a stock, you are betting that it will go down; I don't know how to trade a stock that is moving sideways within a tight price channel).

 

OK, Ambien, here I come.

[The Bear 10]

OK thanks guys. Maybe I should ask my friend if he's comfortable gambling with those naked puts & calls.

 

I'll look at the OIH, but I probably won't be doing anything with options anways. I already trade CL (Crude Oil) but on a short term basis. Can I even scalp with options? I'm not very good at intermediate term trading.

 

The LO options may only be pit traded, i'm not sure.

[dalby 10]

i disagree with one thing

 

as i said, i use naked puts in an INVESTMENT account, not a trading account

 

in this respect, they are not a directional bet at all

 

they are an investment strategy based on perceived value

 

if i have a stock i want to buy if it goes down to 20 and it is currently at 22, i can sell a naked put.

 

if the stock never reaches my target entry price, then i collect some premium

 

if it reaches my target price (a bit below it), then if i get exercised, i have to buy the stock at my strike price

 

which is where i perceived value in it

 

this is one way to use naked puts that is not a drectional bet

[TexasTrader 10]

DALBY:

 

Yes, I have done the same thing myself and it is a (very) good way to purchase stock.

 

However, I would contend that when a naked put is used in this way you are not trading options but rather buying stock.

 

Successful Trading,

TexasTrader

[traderwilliam 10]

Some years ago, i used to know two guys that used to trade naked put/call to collect the premium. One commit suicided and one went bankrupted. That's it.

[weiwei 10]

I know a pro oil-gas trader who write call option for his hedge fund, while his fund made a killing for the pass few years, thanks to big valitility in oil and gas for pass few years.

 

He was doing fine when price of crude oil fractuate in the $18 range. Collected a lot of premium at that time.

 

But he end up getting fired, he loss a lot of money for the fund on those naked call option, because from what I uderstand on writing call, market have to be calm. not volatility to collect money.

 

Another thing with stock options, the spread will put you in a big disadvantage. On stock option each step is $5 on stock that is over $30. (this is out of memory, could be other then $30). while if you buy individual stock it is only 1 cent.

 

I done a calculation a few years back on writing option. You can be 80% to 90% correct and still not making money. In other word, you can be collect those preminum for 8 to 9 time out of 10, but that 1 or 2 time will wipe out you profit.

 

After that, I stay away from options, there are just too many thing against you on options. Trading stock or futures is easier.

 

weiwei

[The Bear 10]

I know a pro oil-gas trader who write call option for his hedge fund, while his fund made a killing for the pass few years, thanks to big valitility in oil and gas for pass few years.

 

He was doing fine when price of crude oil fractuate in the $18 range. Collected a lot of premium at that time.

 

But he end up getting fired, he loss a lot of money for the fund on those naked call option, because from what I uderstand on writing call, market have to be calm. not volatility to collect money.

 

Another thing with stock options, the spread will put you in a big disadvantage. On stock option each step is $5 on stock that is over $30. (this is out of memory, could be other then $30). while if you buy individual stock it is only 1 cent.

 

I done a calculation a few years back on writing option. You can be 80% to 90% correct and still not making money. In other word, you can be collect those preminum for 8 to 9 time out of 10, but that 1 or 2 time will wipe out you profit.

 

After that, I stay away from options, there are just too many thing against you on options. Trading stock or futures is easier.

 

weiwei

 

Interesting comments wei wei.

 

I've been talking to my options friend and he's making money doing his writing but he hasn't been doing it long. He get's like 9 winning positions in a row, but like you said, if you take a HUGE hit, it could wipe out gains significantly. So the key is, can they make enough money fast enough so a big hit doesn't take out 30% of their account in a single trade.