Hello, I had a question that hopefully the experienced options trader of this board can shed some light on. A friend of mine started to selling naked calls strategy as of last December and is doing remarkably well lately averaging 30% return on his money per month albeit using high leverage., effectively almost doubling his account within the last 3 months. So he got me interested in this strategy but after doing some research I found that most of the comments relating to this is the high risk nature of it. My question is, given the fact that most options expire worthless, plus a down market and companies that fall; what is really the risk with this strategy? There's risk involved in all types of trading, but how is naked calls more risky than other types of trading? I know that's the standard reply, but with those odds of the above mentioned elements on your side; where is the risk? I'm thinking the worst case is you give back alot of what you made, yet at these returns, wouldn't you still come out ahead ? Would appreciate insight and input from any experienced traders. Thanks
Most options may expire worthless, but that doesn't mean that the minority of options that expire in the money do not more than make up for the majority that expire worthless out of the money. The risk is that you/your friend lose your entire account within a strong uptrend in a matter of days. At the very least, I'd limit upside risk with selling bear call spreads instead of naked calls.
this point that most options retire worthless is brought up so often and exposes the naivite of inexperienced options traders options have non-linear payoffs and you can have a strategy with for rexample, a 90% succuss rate collecting premium that nonetheless makes no money. e.g selling deep out of the money options naively. This is because occasionally the underlying blows through the strike price and you lose multiples of the premium collected on that trade. It can wipe out many months of previously succesful trades. 90% expiring worthless means nothing in that scenario. It's the nature of the curved payout. This illussion of easy money in options selling causes many newbies to be carried out feet first. Don't misunderstand me, I love options trading and their defined risk characteristics and the inherent edge in certain dynamically adjusted strategies. Just don't be duped by the "wow, 9 out of 10 times this made money" idiocy with this type of instrument.
i am no expert by far, but been playing with options for about a year now. in general naked call/put is not a good idea unless you are monitoring this 930-4 every day, even then you are still powerless against afterhour news. Just look at bsc and leh the last few days. And today's rally. index are less risky than individual stocks, it gives you more time to react and less affected by company news. calls in general are less risky than puts, but if there is a buyout you would still get blown out. Just dont do it, if you must be on the short side, start with spreads, it's not worth it for a new player until you truely understand the risk. Your friend is making $$ because the market is in a downtrend, but when it turns he will get blown unless he can move with the market. And if he can move with the market, then he will make money trading anything - stocks/options/futures etc.. Someone said writing options is not a substitute for good stock(underlying) prediction/analysis. And they are 100% correct.
Selling a naked call is about as risky as its gets with options because your loss is basically unlimited. Say you sell a naked call on a stock that is trading at $ 20 a share. Because you do not own the stock if the stock price goes up you have 2 choices, buy the stock or cover your naked short. Selling naked calls is about the same as shorting a stock with regard to loss potential if the stock goes against you. One problem is when people use to much option leverage for the naked call and are forced to cover . Selling naked puts is a safer bet on lower priced stocks but only good if you think they have bottomed and wont move much in either direction for a while . Once again people do this for the leverage of options with out the exposure of capital to purchase the stock at that given time. However margin requirements force you to have equity in your account to cover the naked put trade if you are forced to buy the stock .
Don't mistake bear market for brains. Of course your friend has been doing great, the market has been doing nothing but going down! However, if the market turns then your friend's high leverage naked call selling is gonna wipe him(her) out!
The above is a very good point for noobs also many forget about the role risk management plays in options trading. It seems so many come on here and forget it with options because they see option buying as a risk management tool in and of itself.