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What Are Naked Options & How Should Traders Use Them?
OVERVIEW
Short “naked” options are calls or puts that are sold that have nothing to limit their risk (shares of stock, long options). It is a bullish strategy when selling a put option and a bearish strategy when selling a call option.
Short Naked Put
DEFINITION
A short naked put is a bullish strategy that is executed by selling a put option. It is a strategy that can be used to buy shares of stock at a lower price, while keeping the premium collected if the stock price does not decrease.
PROFIT/LOSS CHART
DIRECTIONAL ASSUMPTION
IDEAL IMPLIED VOLATILITY ENVIRONMENT
Short Naked Call
DEFINITION
A short naked call is a bearish strategy that is executed by selling a call option without being “covered” by long stock or a long call option. Selling naked calls is an undefined risk strategy.
PROFIT/LOSS CHART
DIRECTIONAL ASSUMPTION
IDEAL IMPLIED VOLATILITY ENVIRONMENT
SETUP
Short Naked Put
Short Naked Call
HOW TO CALCULATE MAX PROFIT / BREAKEVEN(S)
MAX PROFIT
SHORT NAKED PUT
Credit Received
SHORT NAKED CALL
Credit Received
BREAKEVEN(S)
SHORT NAKED PUT
Strike Price - Credit Received
SHORT NAKED CALL
Strike Price + Credit Received
tastylive Approach
Short “naked” options are calls or puts that are sold that have nothing to limit their risk (shares of stock, long options).
Since “naked” options have no options that are purchased against them, they benefit the most from the passage of time (theta decay) and any decreases in implied volatility (IV). As a result, the ideal environment for selling naked options in terms of the premium collected is when IV is high.
CLOSE / MANAGE
WHEN TO CLOSE
Profitable short naked calls and short naked puts will be closed at a more favorable price than the entry price (first goal: 50% of maximum profit)
WHEN TO MANAGE
When trading short naked options, selling an option of the opposing type (i.e. selling a call against a short put that is being “tested”) can be one defense mechanism. This reduces the directional risk of the position and collects more premium, which extends the break-even point.
If the trader’s assumption on the underlying has not changed as expiration approaches, the position can be rolled to the next expiration cycle to extend the time in the trade and collect more premium.
SUPPLEMENTAL CONTENT
Episodes on Naked Options
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