I hear "hidden risks and consequences" over and over and still don't understand it. What am I missing that is hidden? The only risk and consequences I see are leverage/margin related when comparing selling naked options to the synthetic equivalent (and perhaps dividend risks). And, leverage/margin can be an advantage if used wisely. What exactly are people refering to when they speak of "hidden risks and consequences"? Thanks, Ray
You must understand that many rookies go out and trade options and have no idea what they are doing. No one is suggesting that you, Ray, are subject to hidden consequences. One such consequence is having an account that is too small to handle the margin requirement that comes with owning stock - after being assigned. They get a margin call, panic, and don't know what hit them. Sure, the stock is simply sold and all is well again. But that panic is very disturbing. Mark
Thanks, I guess I find it disturbing someone would trade options without that basic level of understanding the risks. I'm new to this but I do my homework so when I hear this phrase over and over, I start to think I'm missing something. - Ray
Most of this is great information if the OP wanted to sell naked options, but his wording makes it very clear that he is interested in selling options naked. I can't claim to have experience in this area, but I would imagine that it would be safer, albeit less enjoyable to sell options naked alone
What if you go long an es future near the top of the range, and sell an index call short to hedge the risk of being long the future. Or would it be better to buy an index put while be long the es future to hedge risk.
Forgive me if I am beating a dead horse here. What people are trying to tell you is that the broker's margin is irrelevant if the underlying moves rapidly and option is exercised. Example: Today, you sell a 50 put on a $52 stock. Tomorrow, 1987 happens again, the market falls 22%, and your stock, which is more volatile than the market, falls 50%. The holder immediately puts the stock to you, so that you pay $5000 for a $26 stock. Forget about any stop you set--there is no guarantee that it will execute prior to the exercise if something like this were to happen overnight. Now multiply this by however many puts you are selling. At this juncture, it seems to me that the $1000 or so you were initially required to keep as margin is an irrelevant number. So you can see that it only makes sense to sell these puts if you really, really want to buy the stock at $50 minus the premium--that is, if you would have bought the stock at $50 minus the premium under any circumstances. And you can also see that it does not make sense to sell too many of these. A small amount every month is reasonable, at least at times when the general market is not going to hell in a handbasket. Some may wish to argue that 1987 won't happen again tomorrow. Well, it probably won't. However, it will happen again, sometime.
PS--Some novice traders do not understand that margin is not some sort of limit on their obligations. I had this conversation with a new futures trader the other day, who kept referring to his margin. The broker tells you to keep a margin--they have to follow some rules to maintain their insurance, satisfy legal requirements, and keep their own ass out of the sling. If you can't satisfy the margin, I suppose they would liquidate your account. However, that's not necessarily the end of it. You still owe them the money. They can come after you in court, garnish your wages, and so forth. My guess is they would not bother will all that for a small account, but who knows? So forget about margin. The number you need to calculate is the absolute maximum amount you can lose. If you can't sleep with that number, this indicates the need to get smaller, trade a more conservative underlying, etc. Again, sorry if I'm being redundant here. I don't mean to lecture. I'm just hoping this might save one person's skin.
Margin and leverage are for experienced traders who understand the risk and can deal with the consequences. It's NOT for noobs.
drcha, No need to apologize for emphasizing the risks of naked options. Noobs need to understand ut BEFORE they dive in, not after. Your post about 1987 is on the mark. I remember quite clearly the empty feeling in the pit of my stomach as the day unfolded... kind of like when a plane loses a few hundred feet of altitude in mere seconds. Ughhhh! As a naked put seller (at that time) who usuallly rolled existing and sold new positions on expration Friday, I knew that I owned every one of them 3 days later (Black Monday was the first trading day after October expiration), Trust me, margin calls aren't pretty... however, they do proovide impetus for learning how to manage risk