Writing Naked Puts & Calls - Risks

[The Bear]

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]

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]

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

the risk in writing naked puts is limited

[The Bear]

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]

	Quote:	dalby
	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]

	Quote:	The Bear
	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]

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]

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]

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]

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"