Hello All:
I sell naked calls every so often and wondered whether I can improve
on my chances of limiting losses.
Lets say we have a 200 strike on a stock selling at 180. If it moves up and
past the strike my loss could be a disaster!!
So, I thought of putting in a buy stop order to buy the stock if it reaches 195.
If it keeps going, I bought at 195 and it gets called away at 200. And if it keeps going
I get another $5 and dont get killed if it hits 220!!
Appreciate all comments and suggestions.
If this concept would work, I will name this strategy as the cash secured Call !
Selling a deep out of the money call has a high probability of profit and may have the added benefit of higher implied volatility(IV) than nearer money strikes, increasing the premium received than would otherwise be the case if there was no skew.
There are missing inputs from your post, making specific suggestions more difficult. Knowing your expected holding time, whether the stock in question was an index or single name, and the conditions which would trigger a trade are just a few considerations.
Generally, selling naked options is inefficient in several ways:
1. Inefficient use of capital - Due to undefined risk, margin requirements on naked options are high, limiting return on capital and having the effect of diluting trading skill. Also consider the effect of increasing IV on your short call position. Compare your original idea to selling an at the money, $180 call and buying the $200 call as protection. If the underlying price were to exceed, say $200, you could close out the trade for less than maximum loss as your protective long $200 call would have value being at the money. In addition, you would know what your maximum loss could be.
2. Trading inefficiency - Although I don’t know what time frame you are looking at, many down moves tend to be short term, potentially making a naked long put a potentially viable alternative on either an extended move, especially if the move involves increasing IV or on a quick, sharp move down over the course of 1 to 3 days. If you don’t have a strong opinion on direction, perhaps an iron condor or directional butterfly would be more efficient.
There are three basic short term scenarios to a short option position. The underlying moves against you immediately and you have to sweat a overnight gap against your position. Short covering can be fierce and while gap ups force earlier shorts to cover. Sometimes gap ups can also encourage new shorts to enter in what are “Obviously ridiculous prices”, creating the stage for yet another short covering squeeze. See exhibit A, daily chart marked “TSLA”. The second scenario is the stock stays flat and time decay works in your favor. The third scenario is the stock moves down sharply in your favor. Do you hold for expiration at this point or free up margin for another trade? Does it feel empty to see a stock move many dollars only for it to help your bottom line a few pennies? Are these pennies gained really worth your time?
It seems to me, efficient option trading involves an opinion on direction or the lack thereof, timing, an opinion on IV, efficient use of capital, and having a trade management plan. Being able to pick the best trading strategy for a given scenario can significantly improve your long term trading results.
Hopefully this and other posts help stimulate ideas for you.
