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naked risk
- Thread starter ra1
- Start date
this story has circulated here many times, but worth reposting nonetheless.
http://www.gladwell.com/2002/2002_04_29_a_blowingup.htm
http://www.gladwell.com/2002/2002_04_29_a_blowingup.htm
this is math. and just like the game theory thread, it seems a lot of people have trouble with math
naked calls have (theoretically) infinite risk
if you write a 30 call on ABCD. ABCD is selling @20
let's say you get $100 premium
you collect yer premium.
nifty
tomorrow ABCD opens @ 1000. (theoretically) possible, due to some amazing new invention. they cured cancer for instance
those calls are exercised, and you are now obligated (you MUST) buy 100 shares of ABCD for $1000 each (that's 100,000 dollars folks) and then sell them to some dood for $30.
that is a $96,900 loss
you keep yer $100 premium, but you had to buy 100 shares @1000 and then sell them to the option holder for $30 each
naked puts are totally different
you write a naked put on ABCD with strike of 20.
you get $100 premium,. ABCD is currently $30 a share
tomorrow, ABCD opens at $1 (really bad news)
you are now obligated to buy 100 shares of ABCD from an option holder for $20 each
costs ya $2000 dollars. you resell them for $1. so, you are out 1$1800
you are out 1900 on the trade, but you still got yer premium
naked puts have LIMITED risk. naked calls have UNLIMITED risk.
that is indisputable.
even if the stock goes to zero, if you wrote a naked put yer max theoretical loss is 100*strike price (and of course you keep yer premium)
so, premium aside, yer max loss is about 100* the strike price of what you wrote.
yer max loss on a naked call is INFINITE, but realistically speaking it may not be INFINITE but the realistic risk is MUCH larger
i write naked puts on stocks i would want to own ANYWAYS if they went down in price because they are investment quality stocks, and on a lynchian basis, i'd want to own them on a dip.
these are totally different risk parameters
fwiw, a broker (knowing these risks) is far more likely to approve yer account for naked puts vs. naked calls.
a naked call can wipe yer account out.
a naked put, assuming that 100 shares of the stock @ the premium price is not going to break yer bank, won't
naked calls have (theoretically) infinite risk
if you write a 30 call on ABCD. ABCD is selling @20
let's say you get $100 premium
you collect yer premium.
nifty
tomorrow ABCD opens @ 1000. (theoretically) possible, due to some amazing new invention. they cured cancer for instance
those calls are exercised, and you are now obligated (you MUST) buy 100 shares of ABCD for $1000 each (that's 100,000 dollars folks) and then sell them to some dood for $30.
that is a $96,900 loss
you keep yer $100 premium, but you had to buy 100 shares @1000 and then sell them to the option holder for $30 each
naked puts are totally different
you write a naked put on ABCD with strike of 20.
you get $100 premium,. ABCD is currently $30 a share
tomorrow, ABCD opens at $1 (really bad news)
you are now obligated to buy 100 shares of ABCD from an option holder for $20 each
costs ya $2000 dollars. you resell them for $1. so, you are out 1$1800
you are out 1900 on the trade, but you still got yer premium
naked puts have LIMITED risk. naked calls have UNLIMITED risk.
that is indisputable.
even if the stock goes to zero, if you wrote a naked put yer max theoretical loss is 100*strike price (and of course you keep yer premium)
so, premium aside, yer max loss is about 100* the strike price of what you wrote.
yer max loss on a naked call is INFINITE, but realistically speaking it may not be INFINITE but the realistic risk is MUCH larger
i write naked puts on stocks i would want to own ANYWAYS if they went down in price because they are investment quality stocks, and on a lynchian basis, i'd want to own them on a dip.
these are totally different risk parameters
fwiw, a broker (knowing these risks) is far more likely to approve yer account for naked puts vs. naked calls.
a naked call can wipe yer account out.
a naked put, assuming that 100 shares of the stock @ the premium price is not going to break yer bank, won't
I heard your argument many times, but in my opinion it is flawed.
If you're bullish on a stock: buy it. Selling a put limits your upside keeping your risk almost intact. You may need less margin, but if you overleverage your risk'll increases faster than your potential gain.
Also, selling a put means shorting implied volatility. You have to take this in consideration in your money management.
If you're bullish on a stock: buy it. Selling a put limits your upside keeping your risk almost intact. You may need less margin, but if you overleverage your risk'll increases faster than your potential gain.
Also, selling a put means shorting implied volatility. You have to take this in consideration in your money management.
Quote from whitster:
... i write naked puts on stocks i would want to own ANYWAYS if they went down in price because they are investment quality stocks, and on a lynchian basis, i'd want to own them on a dip.
Quote from cnms2:
I heard your argument many times, but in my opinion it is flawed.
If you're bullish on a stock: buy it! Selling a put limits your upside keeping your risk almost intact. You may need less margin, but if you overleverage your risk'll increases faster than your potential gain.
If you're not bullish: don't buy it! Look for something else.
Also, selling a put means shorting implied volatility. You have to take this in consideration in your money management.
A naked put or naked call is no different from actually buying or shorting a stock, risk-wise. There is a difference benefit-wise, but that's why the probabilities are strongly skewed in your favor. So, your question is no different from, "is it more risky to be long stock or short stock?"
The three marginal differences in risk between selling puts and calls:
1) Broad based indicies (such as the Dow) have averaged a 4.5% increase per year. Selling calls is 4.5% more risky over a year. (Skewing the normal distribution)
2) Puts have early exercise benefits which short calls rarely have making short puts more risky.
3) Calls have early exercise benefits in the case of dividends, which make short calls more risky.
The GOOG example about how puts are more risky is just too limited. Look at LNUX or FMD over the last couple weeks--prices can be equally upwardly explosive.
If you believe prices are lognormally distributed (which is what Black-Scholes, Merton, and most other pricing models are based upon) or Cauchy distributed (which is what Mandelbrot and Nassim Taleb propose), then there's absolutely no difference in risk between a put and a call.
Incorporate skew, and a call is perhaps 4.5% more risky then a put.
The three marginal differences in risk between selling puts and calls:
1) Broad based indicies (such as the Dow) have averaged a 4.5% increase per year. Selling calls is 4.5% more risky over a year. (Skewing the normal distribution)
2) Puts have early exercise benefits which short calls rarely have making short puts more risky.
3) Calls have early exercise benefits in the case of dividends, which make short calls more risky.
The GOOG example about how puts are more risky is just too limited. Look at LNUX or FMD over the last couple weeks--prices can be equally upwardly explosive.
If you believe prices are lognormally distributed (which is what Black-Scholes, Merton, and most other pricing models are based upon) or Cauchy distributed (which is what Mandelbrot and Nassim Taleb propose), then there's absolutely no difference in risk between a put and a call.
Incorporate skew, and a call is perhaps 4.5% more risky then a put.