33 lines
2.2 KiB
Plaintext
33 lines
2.2 KiB
Plaintext
Naked Call
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A naked call is when a trader shorts a call without having stock or other
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options to cover or protect it. Since the call is uncovered, it is one of the
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riskier trades a trader can make. Recall the at-expiration diagram for the
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naked call from Chapter 1, Exhibit 1.3 : Naked TGT Call. Theoretically,
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there is limited reward and unlimited risk. Yet there are times when
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experienced traders will justify making such a trade. When a stock has been
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trading in a range and is expected to continue doing so, traders may wait
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until it is near the top of the channel, where there is resistance, and then
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short a call.
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For example, a trader, Brendan, has been studying a chart of Johnson &
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Johnson (JNJ). Brendan notices that for a few months the stock has trading
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been in a channel between $60 and $65. As he observes Johnson & Johnson
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beginning to approach the resistance level of $65 again, he considers selling
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a call to speculate on the stock not rising above $65. Before selling the call,
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Brendan consults other technical analysis tools, like ADX/DMI, to confirm
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that there is no trend present. ADX/DMI is used by some traders as a filter
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to determine the strength of a trend and whether the stock is overbought or
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oversold. In this case, the indicator shows no strong trend present. Brendan
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then performs due diligence. He studies the news. He looks for anything
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specific that could cause the stock to rally. Is the stock a takeover target?
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Brendan finds nothing. He then does earnings research to find out when
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they will be announced, which is not for almost two more months.
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Next, Brendan pulls up an option chain on his computer. He finds that
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with the stock trading around $64 per share, the market for the November
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65 call (expiring in four weeks) is 0.66 bid at 0.68 offer. Brendan considers
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when Johnson & Johnson’s earnings report falls. Although recent earnings
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have seldom been a major concern for Johnson & Johnson, he certainly
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wants to sell an option expiring before the next earnings report. The
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November fits the mold. Brendan sells ten of the November 65 calls at the
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bid price of 0.66.
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Brendan has a rather straightforward goal. He hopes to see Johnson &
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Johnson shares remain below $65 between now and expiration. If he is |