Playing The Options Game Naked
Buying naked calls and puts is the simplest trade to put on. You pick a strike price, an expiration and decide whether to buy a put or a call based on your view of the market. This strategy requires you to be correct on direction, magnitude and direction of price movement. Getting price movement correct consistently enough to profit on naked put and call options is extremely difficult. Considering 80% of options expire worthless suggest that this strategy would need to generate profit on a 20% win rate. For this reason we are not fans of "going naked". High volatility markets make naked option even more challenging as price dances in and out of the money.
Putting Some Clothes On Your Options
Buying a put or a call require you to have the accuracy of a sharp shooter to make money. Using credit spreads are more like horseshoes. You get close and you can still make money. Option Credit Spreads allow you to sell an option and pocket the premium with a fixed maximum loss scenario. This is done by selling an option for a credit into your account. You then buy and option to limit your downside exposure. For example if I were bullish on Microsoft and MSFT was trading at 20, you could sell 17.5 put options with 40-60 days left to expiration. You could collect about $1.00 in premium per 100 shares per single option contract. If you bought 5 contracts you would collect $500 in premium. You could then buy a 15 put in the event you are very wrong. Maximum risk would be $2.50 which is the distance between the strikes less premium collected of $1.00 making maximum loss $150 or $750 If 5 contracts were done.
There is still an opportunity to manage the option credit spread every day until expiration. If MSFT in our example where to zoom up to $25 lets say, the 17.5 put option that was sold would have lost most of its value. The option could then be bought back to collect most of the available premium without any further exposure for what would be little gain. Stock options are about managing risk and not necessarily being a star stock picker. Options on stocks, futures or commodities gives you options. You can morph an options position to what is best for the current market. The key is to not commit too much capital and find that you don't have enough capital to hedge or morph your position to what's best for the immediate market condition.
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