Writing Naked Puts & Calls - Risks

[Z_trade]

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

[dalby]

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]

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]

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]

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]

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]

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]

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]

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]

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.