Sellin Naked Options
Naked options can be extremely dangerous. What are these naked options? Whenever an investor sells an options that is not backed by either a stock or another option contract it is a naked option.
There are two different types of options, call options and put options. Whenever you sell a call option you simply take the obligation of selling the stock at a given price in exchange for getting a premium up front.
There is no riskier trade then selliing a call without having something backing it up. The amount that you could possibly lose is unlimited. For instance if you sell the $40 call you will be obligated to sell the stock at $40, so if it goes up to $41 or higher you will have to buy it at that price and sell it at $40.
There isn’t a limit to how far a stock is able to move upward. This means that there is also no limit to how much an investor could potentially lose when selling a call option. That is why I do not sell naked calls, it simply has too much risk involved with it.
There is a second type of naked option and it comes with a little less risk. When you sell a put option you take on the obligation to buy the stock at a specific price on or before a given date. For example if you sell the $40 put you would have to buy it at $40 if you are called out.
That means there is a limit, the most you can lose when selling naked puts would be the strike price of the option, in this case $40. This makes it a little bit less risky, but it still comes with a huge loss potential.
One way to limit the risk would be to create an option spread strategy by either buying another option on the stock or the stock itself. For example if you sold the $40 call you could also buy the $45 call. You will have to use some of your profits to buy the 2nd call, but your risk will go from being unlimited to $5, a huge difference.
