29 lines
2.1 KiB
Plaintext
29 lines
2.1 KiB
Plaintext
CHAPTER 5
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Naked Call Writing
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The next two chapters will concentrate on various aspects of writing uncovered call
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options. These strategies have risk ofloss if the underlying stock should rise in price,
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but they offer profits if the underlying stock declines in price. This chapter on
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naked, or uncovered, call writing - demonstrates some of the risks and rewards
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inherent in this aggressive strategy. Novice option traders often think that selling
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naked options is the "best" way to make money, because of time decay. In addition,
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they often assume that market-makers and other professionals sell a lot of naked
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options. In reality, neither is true. Yes, options do eventually lose their premium if
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held all the way until expiration. However, when an option has a good deal of life
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remaining, its excess value above intrinsic value what we call "time value premium"
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- is, in reality, heavily influenced by the volatility estimate of the stock. This is called
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implied volatility and is discussed at length later in the book. For now, though, it is
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sufficient to understand that a lot can go wrong when one writes a naked option,
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before it eventually expires. As to professionals selling a lot of naked options, the fact
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is that most market-makers and other full-time option traders attempt to reduce their
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exposure to large stock price movements if possible. Hence, they may sell some
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options naked, but they generally try to hedge them by buying other options or by
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buying the underlying stock.
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Many novice option traders hold these misconceptions, probably because there
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is a general belief that most options expire worthless. Occasionally, one will even hear
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or see a statement to this effect in the mainstream media, but it is not true that most
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options expire worthless. In fact, studies conducted by McMillan Analysis Corp. in
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both bull and bear months indicate that about 65% to 70% of all options have some
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value (at least half a point) when they expire. This is not to say that all option buyers
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make money, either, but it does serve to show that many more options do not expire
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worthless than do.
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