36 lines
2.8 KiB
Plaintext
36 lines
2.8 KiB
Plaintext
138 Part II: Call Option Strategies
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"Suitability" also means not risking nwre nwney than one can afford to lose. If
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one allows the "maximum" margin, then he won't be risking a large portion of his
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equity unless he is unable to cover when the underlying trades through the strike
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price of his naked option. Gaps in trading prices would be the culprits that could pre
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vent one from covering. Gaps are common in stocks, less common in futures, and
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almost nonexistent in indices. Hence, index options are the options of choice when it
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comes to naked writing. Index options are discussed later in the book.
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Finally, there is one more "rule" that a naked option writer must follow:
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Someone has to be watching the position at all times. Disasters could occur if one
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were to go on vacation and not pay attention to his naked options. Usually, one's bro
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ker can watch the position, even if the trader has to call him from his vacation site.
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In sum, then, to write naked options, one needs to be prepared psychological
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ly, have sufficient funds, be willing to accept the risk, be able to monitor the position
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every day, sell options whose implied volatility is extremely high, and cover any naked
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options that become in-the-money options.
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RISK AND REWARD
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One can adjust the apparent risks and rewards from naked call writing by his selec
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tion of an in-the-money or out-of-the-money call. Writing an out-of-the-money call
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naked, especially one quite deeply out-of-the-money, offers a high probability of
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achieving a small profit. Writing an in-the-money call naked has the most profit
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potential, but it also has higher risks.
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Example: XYZ is selling at 40 and the July 50 is selling for½. This call could be sold
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naked. The probability that XYZ could rise to 50 by expiration has to be considered
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small, especially if there is not a large amount of time remaining in the life of the call.
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In fact, the stock could rise 25%, or 10 points, by expiration to a price of 50, and the
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call would still expire worthless. Thus, this naked writer has a good chance of realiz
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ing a $50 profit, less commissions. There could, of course, be substantial risk in terms
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of potential profit versus potential loss if the stock rises substantially in price by expi
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ration. Still, this apparent possibility of achieving additional limited income with a
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high probability of success has led many investors to use the collateral value of their
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portfolios to sell deeply out-of-the-money naked calls.
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For those employing this technique, a favored position is to have a stock at or
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just about 15 and then sell the near-term option with striking price 20 naked. This
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option would sell for one-eighth or one-quarter, perhaps, although at times there
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might not be any bid at all. At this price, the stock would have to rally nearly one- |