Unlimited Loss is a larger myth than the complication to understanding options trading.
The truth is not complex. It’s the right time that we correct our misconceptions and put the fear to rest. Theoretically naked options carry the potential of unlimited risk. To be even more precise naked calls carry unlimited risk rather than naked puts.
In the real world, the risk is manageable and controllable that unlimited
risk becomes meaningless. Few million of traders are selling naked options making a good money on their investment.
The caveat is that if you are just selling a call option before the start of a bull run and hold on to it for next few years and do nothing about it except maintaining the margin money on regular basis then, in reality, you sitting on top of unlimited losses. Even a simple education of stop-loss can change the unlimited loss to manageable loss.
- 1 RISK CAN BE MANAGED
- 2 HOW TO MANAGE UNLIMITED RISKS
- 3 #1. Monitor the Position
- 4 #2. Stoploss
- 5 #3. Spread
- 6 #4. Hedging
- 7 #5. Selling Unreasonable
- 8 #6. Right Derivative
RISK CAN BE MANAGED
When selling or writing the naked options done in a disciplined manner and along with proper protective trading technique is a definitely manageable risk. Rather its risk equals to buying options. Now, talking about professional traders point of view they would consider that option buying is riskier and they avoid buying options. Or limit the option buying only to the extent it’s required to hedge.
Historical statistics show that more option buyers lose money than the option sellers. Options are decaying asset and lose their value each day. A dilemma that an option buyer faces is that his option value loses money daily and he earns only if their movement of the underlying in one direction.
HOW TO MANAGE UNLIMITED RISKS
#1. Monitor the Position
This is the simplest of concept, unlike an investment which can be left unattended for years that’s not true for option positions. Based on the strategy you have selected for options trading regular monitoring is a must. You don’t have to keep focusing on the computer all the time to monitor the position that would only cause you more stress. One has to have an overview of how the underlying is reacting and is it against our position. Now there are two options if the direction of the underlying is not in our favour. The first option is to exit the position if the stop-loss is triggered and the second option is right hedging or adjustment of the position. Even if the option seller does nothing other than buying back the position his risk is covered.
We always tell all our subscribers that never move the stop-loss in the opposite direction of the target.
So easy to listen, understand but very tough to implement. Most of the times the stop-loss is revised during the trading hours. You should read the 11 Rules of Trading Most Successful Trader Follow. This is not something new but a simple explanation would be to manage your risk to reward ratio and ensure that when stop loss is triggered one should either adjust the position or get out of the position.
Spreads are options trading strategy where a call option is bought and sold at different strike prices for the same month of expiry.
This option strategy has limited profit and limited loss. Spread are very easy to construct and easy to monitor. They are one of the most basic options strategies, to begin with. Trading spreads initially give the confidence one option traders needs to enter into the options trading. Many professional options traders have spread as one of the strategies in their portfolio.
Hedging is the practice of buying and holding an option for the purpose of reducing the risk. This is the definition that if found in invesopedia.com which suits the most.
Hedging is the practice of purchasing and holding securities specifically to reduce portfolio risk. These securities are intended to move in a different direction than the remainder of the portfolio – for example, appreciating when other investments decline. A put option on a stock or index is the classic hedging instrument.
Hedging or option protection can be done for blocking the profit or prior to expected volatility. This ensures that unlimited risk is reduced.
#5. Selling Unreasonable
Ideal Expiry Days to sell an option is 60 days to expiry to 90 days to expiry. It becomes very unreasonable to sell an option contract with days to expiry running in years. Options cannot be treated investment products that run over a period of time in terms of years. The time period available to sell very long-term options usually ranges up to almost 5 years.
#6. Right Derivative
Derivative options with very low option trading volume are a trap you sell a wrong option at the wrong price with no volumes it would be difficult for your to exit the option and the only way to exit the option would be to exercise it. And at times this would effectively trap you with the options unless and until you are profitable e.i. the price of the underlying moves in your direction you would regret that you are unable to exit the option or unable to exit your desired.
The Time Is Running Out! Think About These 6 Ways To Change Your Myth Of Unlimited Losses In Naked Option Selling
Get Rid Of Myth Of Unlimited Losses In Naked Option Selling Problems Once And For All.
But in the meantime, here’s a tip you can use right away. You’ll have a better strategy on your options trading in 20 minutes by following these two simple steps:
Go Look at your Trading Strategy Now.
Take out every reason why you were fearful of selling a naked option.
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Also published on Medium.