Newbie question on income by selling calls

[spindr0]

-------------------------------------------------------------------------
Another risk is the gap risk. If GOOG moves up and closes slightly below 590 and then gaps up a lot, you might buy GOOG stock at a price higher than 590 with the buy stop order.
-------------------------------------------------------------------------

Quote from Neutral:

Yeah, that part I already thought about. One would have to dabble in "well-behaved" stocks. Biotech, for example, would be a bad choice, I think. Thanks for your answer.

Even "well behaved" stocks can be bad boys

 

[gkishot]

Quote from Neutral:

Do you mean you can't derive income from selling options without betting right on direction on average? Because an occasional loss doesn't necessarily mean "you can't derive income from selling options".
Anyway, could you please explain your statement in more detail?

Occasional loss means that you can't repeat this process next time ( let it be next month ) with your capital to the contrary of the classical definition of income. One occasional loss puts an end to your income stream.

 

[Neutral]

Quote from spindr0:

-------------------------------------------------------------------------
Another risk is the gap risk. If GOOG moves up and closes slightly below 590 and then gaps up a lot, you might buy GOOG stock at a price higher than 590 with the buy stop order.
-------------------------------------------------------------------------

Even "well behaved" stocks can be bad boys

Yeah. It's just a matter of putting the odds in one's favor. Surprises should be a part of the plan. I am striving to survive even if a strategy turns out to be a genuine loser due to bigger-than-expected-surprises. In other words, no strategy should be a very big part of one's repertoire, and maximum loss should be defined (in the context of this discussion, that means the "naked" call should probably be turned into a spread, even if a wide one, for the sake of defining risk, although it's hard to imagine a big gap up, short of a diamond mine being discovered in the front yard of a boring, "well-behaved" company.)

Thank you very much for your thoughtful and helpful responses.

 

[Neutral]

Quote from gkishot:

Occasional loss means that you can't repeat this process next time ( let it be next month ) with your capital to the contrary of the classical definition of income. One occasional loss puts an end to your income stream.

I guess it's a matter of definition. To me, "income" (as opposed to "trading") means that it's a positive-expectation strategy based on estimated probabilities, without any particular "trading prowess", in the form of guessing market direction, be it prices or volatility. I know the distinction is blurred.

Having said the above, I think it's insane to put 100% percent of capital at risk in one trade. I wouldn't want the maximum risk on any trade to be more than a few percent of total capital. I might risk closer to 10% if the maximum theoretical loss is extremely unlikely, and the "normal" outlier loss is, say, 20% of that. That's it. In my definition, occasional painful loss should not come anywhere close to terminating or seriously denting my capital, and that has nothing to do with whether I am executing an "income" strategy, or trying to outsmart the market by guessing direction in a sharper, more explicit way.

I said I am a newbie. That shouldn't mean I am crazy! ;-)

Thanks for your response.

 

[Neutral]

Quote from SomeYoungGuy:

I just don't understand the concept of hedging a trade like this.

You should always be able to ask yourself "If I was flat, would I enter into this position?" If the answer is Yes, stay in. If the answer is No, get out.

Another way to think about it is, Would you invest more in the position if you spontaneously had more money in your account?

Let's say you sell your option at $10 because you think you have an edge and you're odds say you're going to make money. Oops price moved against you, now your option is $1. Your rich aunt dies, so sad, but she left you $100. Would you sell another option at $1? I think you would say Oh hell no, price has already moved against me. Then WTF are you doing in the position?!?

How many times have I heard someone say "I got in at $10 then it went to $20 and now it's back down to $10. If I didn't already own it, I would never buy it."

If you don't get it, well, I'm not going to tell you. I don't tell my Aunt Cathy to sell either. She isn't looking for investment advice, she's just making conversation and looking for a shoulder to cry on.

I sympathize with your general sentiment. However, I think it's not as simple as that. Apart from the finite amount of attention we can devote to the entire universe of trading possibilities, whether a trade "moved against you" depends on your initial purpose. If your purpose is to keep a good portion of the premium you collected, then it doesn't matter if the stock moved higher while your position is technically categorized as "bearish". Abandoning the trade because the underlying went bullish while the position is technically bearish would be a confused response. In its simplest form, when one sells an OTM call, one is not really betting that the stock will fall; one is betting that the stock will not rise to the strike price. If there is a way to stem further losses until expiration, and the capital you tie up in the process doesn't have a better use (because you just aren't good enough to spot better opportunities, or the potential gains are not sufficiently larger than the certain loss you'll take by abandoning your current short call position), then it makes sense to keep tormenting yourself with the soured trade until expiration to keep part of the premium and come ahead, or minimize losses. That's my take. I am quite willing to be taught otherwise.
Thanks for your response.

 

[heech]

Quote from Neutral:

. Presumably, if the stock runs from 550 to 590, it would take a while (so close to expiration date), and have a reasonable momentum, mitigating the downside risk. But then, I don't know much.

This is where your view is in trouble. If you really believe momentum is a key factor and further upside moves are more likely than a downside move... You shouldn't bother with options at all.

Just trade the underlying, and if youre right, you'd still be a very successful man.

 

[Neutral]

Quote from heech:

This is where your view is in trouble. If you really believe momentum is a key factor and further upside moves are more likely than a downside move... You shouldn't bother with options at all.

Just trade the underlying, and if youre right, you'd still be a very successful man.

You seem to be in agreement with the "just delta-hedge, don't buy the whole lot" advice, which is quite reasonable. Thanks.