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THE NAKED TRUTH: SELLING OPTIONS WITHOUT PROTECTION IS A ROOKIE MISTAKE

By John Persinos • October 14, 2024 • Stocks to Watch

Printable PDF

Editor’s Note: One of the dumbest mistakes that options traders can make is
failing to understand the full risk of selling naked options, particularly naked
call options. Selling naked options refers to selling options without holding
the underlying asset or another offsetting position, which leaves the trader
exposed to potentially unlimited losses. Below is a detailed breakdown of why
this is a major mistake, often made by novices.

--------------------------------------------------------------------------------

LACK OF UNDERSTANDING OF RISK EXPOSURE

When traders sell naked calls, they are betting that the stock or asset won’t
rise above the strike price. If it does, the seller is obligated to sell the
underlying asset at that price, even if its market value is significantly
higher. This can lead to unlimited losses because theoretically, the stock’s
price can rise infinitely. Many inexperienced traders focus on the premium they
collect from selling the call, underestimating the risk of a massive price
increase.

For example, let’s say a trader sells a naked call with a strike price of $100,
expecting the stock to stay below that level. If the stock skyrockets to $150,
they now need to purchase the stock at $150 to fulfill their obligation to sell
at $100, leading to a $50 per share loss (excluding the premium they collected).
In highly volatile markets, this kind of scenario is not uncommon, especially
with fast-moving stocks or during earnings announcements.

OVER-LEVERAGING WITH LIMITED CAPITAL

Options are inherently leveraged instruments, meaning a small amount of capital
can control a larger portion of the underlying asset. Traders who don’t
understand this risk can quickly over-leverage, believing that selling naked
options is a fast way to generate income. However, one bad trade can wipe out an
entire account.

Without sufficient capital to cover the potential losses, traders may face
margin calls, where brokers demand additional funds to maintain their position.
Failure to meet these margin calls can result in the broker liquidating other
assets in the trader’s portfolio, causing further financial damage.

IGNORING VOLATILITY AND MARKET MOVEMENTS

Options prices are significantly influenced by implied volatility (IV). Traders
often sell options when IV is low, thinking the price movement will remain
muted. However, when IV suddenly spikes—due to unexpected news, earnings
reports, or geopolitical events—the prices of options also rise dramatically,
leading to a larger loss than anticipated. Traders who don’t pay attention to
volatility and only focus on price movement can find themselves caught in sharp
market swings.

Many novice traders fail to hedge their positions, either by not purchasing
protective options or not employing stop-loss measures. For example, traders
could use a protective put or buy call options to limit potential losses, but
neglecting these strategies leaves them fully exposed to sharp spikes in
volatility and catastrophic outcomes.

Instead of having a well-thought-out plan, traders sometimes rely on hope. They
may sell naked options and assume the market will behave in a certain way based
on personal bias or emotion.

When the market moves against them, rather than cutting their losses, they
“hope” it will reverse. This wishful thinking often leads to larger losses as
the market continues to trend against their position.

WATCH THIS VIDEO: Jim Fink Reveals the Keys to Unlocking Wealth

PS: I’ve just described a manifestation of the “dumb money.” Now, I want you to
meet someone who epitomizes the smart money…Mr. Jim Fink.

My colleague Jim Fink has made a fortune for himself trading options…and he’s
ready to tell all.

As chief investment strategist of Velocity Trader, Jim Fink has devised a
methodology that generates market-thumping gains…in up or down markets and
regardless of political uncertainty.



One of the most important presidential elections in our lifetime is just around
the corner. Many investors are nervous and hunkering down. But not Jim.

In a new presentation, Jim Fink explains the simple strategy he uses to rake in
gains of 104%, 164%, and 203%…in as little as 72 hours. Even in this topsy-turvy
election year.

Can Jim’s election-year trades really be this profitable? Click here to find
out.

--------------------------------------------------------------------------------

John Persinos is the editorial director of Investing Daily.

Subscribe to John’s video channel:

 


ABOUT THE AUTHOR

John Persinos
Bio | Archive
John Persinos is the editorial director of Investing Daily, overseeing such
publications as Personal Finance, Utility Forecaster, Profit Catalyst Alert,
Rapier's Income Accelerator, Income Forecaster, and Marijuana Investing Daily,
among others. John also writes the Mind Over Markets daily stock market recap,
and he's the chief investment strategist of Marijuana Profit Alert.

 
John has decades of experience in the technology and political realms. He has
worked as a staff editor at Inc. and Venture magazines, and written for
Kiplinger's, Street Authority, Investing Answers, and TheStreet.com, to name a
few. In a career that has spanned more than 40 years, John has been diligently
and prolifically covering the news and its impact on investors.

 
John also has experience with the inner-workings of Capitol Hill, serving as a
press secretary to U.S. Rep. Byron Dorgan (D-ND). John started his career as a
daily newspaperman with The Orlando Sentinel.

 
John holds undergraduate and graduate degrees from Boston University. He also
completed the Davenport Fellowship in Business and Economics Reporting at the
University of Missouri (Columbia).

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