What about this for a strategy?

Discussion in 'Strategy Development' started by drosengarden, Aug 29, 2008.

  1. Admittedly - I am new - so be gentle with me, please. I bruise easily.

    But here's my latest brain scheme:

    Find a high volume, volitile stock that has out of the money or at the money call options with premiums that are 9% of the stock price or greater.

    Buy the stock.

    Sell the call options.

    And for downside protection - SHORT the stock by the same amount you have purchased.

    When the stock drops below the price you originally entered you are both long and short the stock making the price movements a wash.

    When the stock is above the price you originally entered you are only long and catching any gains in the price of the stock UP TO the amount of the strike price of the call option (in the event you get called out.)

    Ok - so somebody tell me I'm crazy - shoot holes in it - tear to pieces - but PLEASE - be gentle!!!

  2. OK. I'll bite.

    How is this not simply a short call position since the long and short "wash each other out"?
  3. So what I think I'm reading is that you sell a call WITHOUT owning the underlying stock? CAN YOU DO THAT?

    And also, wouldn't it be safer to do what I'm proposing because you know exactly what your cost basis is in the event you get called out of the stock?

    Oh-and thanks for not beating me up!

  4. Yes. Its called naked call writing. You don't have to own the stock, just hold cash as margin in your account.

    What you are suggesting requires more commissions than what is basically a short call position.

    If you don't own the underlying, you may not know the price you will have to purchase the stock at (for delivery) if you get called out. On the flipside, you don't bear the risk of losses if the underlying you are holding declines in value (more than the premium you have collected from selling the call).

    You are welcome.
  5. If you have to ask, I strongly suggest paper trading options first.
    Yes you can sell options naked. How much cash do you need? I can vary. Initially you would need 25% of the underlying. After you sell the call you still need 25% of the underlying AND whatever the market price of the call. Leverage can be higher than that in many cases though.
    If you going to start trading options. Just nibble a little to start, perhaps a simple, directional low risk spread.
  6. You can short stock, bonds, futures, calls, puts and whatever else trades.

    Your "hedge" makes no sense because long and short the same stock means you have zero position in the stock and no hedge at all.

    Naked shorting of calls and puts is very risky for people who don't know what they are doing.

    KISS works best in all markets.
  7. So several of you have enlightened me to naked calls. I guess I understood the concept - just not realizing that's basically what I was creating.

    But then in this case (naked call) what would be the best risk protection while you're "waiting it out" to either get called or option expire?

    In this case it would seem that buying the stock long when it goes above strike price and selling out of the position when it drops below the strike price would be the best "stop loss" here.

    Would this be correct?

    If not - what is the better (best) way?

    Does anybody use this strategy? How do you make ir work out?

    Thanks again to all.
  8. I would suggest you look into vertical spreads.

    In your example, if you are bearish on the underlying, just buy a FOTM call to cap the risk on the trade.

    If the underlying ends up below the strike prices of both the options, you get to keep the balance credit (credit recieved from shorting the OTM call minus debit from purchasing the FOTM call).

    If the underlying ends up above both strike prices, your maximum loss is equal to the difference between the two strikes minus the credit you recieved upon setting up the spread.

    You should look into some books such as Natenberg or McMillan as well as online tutorials.