# Naked calls/puts for income



## dazers (7 July 2008)

Hello everyone,
I thought that a good strategy might be to write conservative out of money naked calls (or puts i suppose) for such stocks as BHP and RIO, because their premiums are higher than lower priced stocks. The risk is also less than if I tried to get that premium from a lower priced stock.

With only several thousand on credit to work with, this is enough to pay the margin quoted on the ASX website.
So is there a broker in Australia that would let me do this? Or is this strategy bogus?


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## MRC & Co (7 July 2008)

B O G U S.

What are you going to do if you are exercised?

What is RIO, near $120 these days?

Say you write a naked put at a strike of $100, it falls to $90.  

You pay 100 x 1000 (ASX puts are in 1000 bundles I believe as opposed to US 100 bundles).  So you need $100k to cover your purchase.  You have several k plus premium, probably not enough to cover the net difference, let alone cover being exercised initially.


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## dazers (7 July 2008)

MRC & Co said:


> B O G U S.
> 
> What are you going to do if you are exercised?
> 
> ...




Yeah I would monitor the position and close out to stop losses at a certain point, so i would never let myself be exercised. So is there a broker around here somewhere?


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## MRC & Co (7 July 2008)

dazers said:


> Yeah I would monitor the position and close out to stop losses at a certain point, so i would never let myself be exercised. So is there a broker around here somewhere?




But what if it gaps down at open with that type of leverage?  Stranger things have happened in this market.

Way way way too risky for someone with only several grand (credit?).

You can trade options yourself through IB, this is what I use for all my trades these days.  Except hold my longer termers over at E-trade.

But man, at least buy several grand (if you have several grand in the bank) worth of a decent stock which pays a decent dividend and write covered calls over a 6 month period or so if you want to generate some income in this environment.  Risk then is only capital depreciation, but you are still guaranteed the income. 

Cheers


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## mazzatelli1000 (9 July 2008)

dazers said:


> I thought that a good strategy might be to write conservative out of money naked calls (or puts i suppose) for such stocks as BHP and RIO, because their premiums are higher than lower priced stocks. The risk is also less than if I tried to get that premium from a lower priced stock.




Conservative??!?! Theoretically unlimited loss for calls and potential large losses for naked puts



			
				dazers said:
			
		

> Yeah I would monitor the position and close out to stop losses at a certain point, so i would never let myself be exercised. So is there a broker around here somewhere?




MRC is spot on about the underlying gapping overnight. You wont be able to defend against exercise.



			
				MRC & Co said:
			
		

> But man, at least buy several grand (if you have several grand in the bank) worth of a decent stock which pays a decent dividend and write covered calls over a 6 month period or so if you want to generate some income in this environment




Your advocating covered calls which is a synthetic short put, which was what dazer was asking in the first place.


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## Mofra (9 July 2008)

MRC, have you considered simple 2-leg net credit spreads (Bull put/call bear spreads)?

You will have a surpising amount of flexibility in terms of your risk tolerances, can set-up a maximum cash-loss within opening the strategy and you can sometime catch a little bit of IV scew which helps with slippage on 2 positions. If you ratio the long leg your theoretical max loss can be close to 0 whilst still gleaning a reasonable premium on a risk/reward basis.

Cheers


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## MRC & Co (9 July 2008)

mazzatelli1000 said:


> Your advocating covered calls which is a synthetic short put, which was what dazer was asking in the first place.




Yes, I have heard this before, but it confuses me!  

A covered call, how can he loose money?  Is it not impossible to end up worse than when you begun?  You will only miss out on any further profits above your strike?  

As opposed to a naked put?  Where anything below will cost you the difference out of pocket?  

Mofra, bull put and bear call credit spreads were the main option strategy I was looking at and seriously considering using.  Though, too larger swings one way or the other (at the moment) for me to take a bear or bull position on the market at any given time.  I am trying to simply hedge longs and shorts, adding to one as the market builds momentum in that direction.  If the market starts trending, definately a low risk way to take advantage of that directional bias.


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## mazzatelli1000 (9 July 2008)

MRC & Co said:


> Yes, I have heard this before, but it confuses me!
> 
> A covered call, how can he loose money?  Is it not impossible to end up worse than when you begun?  You will only miss out on any further profits above your strike?




Covered call is initially a debit strategy.

Say you initiate a covered call believe the stock will stay above $10

Buy 1000 stock at $10 e.g. $10,000 and get $1,000 premium for first month (sold a call at say strike $15) = $9,000 debit
If the stock falls to $0 straight away - you lose $9,000



> As opposed to a naked put?  Where anything below will cost you the difference out of pocket?




Naked Put is initially a credit strategy
You receive e.g. $1,000 premium up front.
Your collateral is sitting in your account
If the stock collapses your short put is exercised and you fork out money for a stock that has no value.
Say the short put strike is $10 since you believe the stock will stay above $10

If the stock collapses and you are exercised you fork out $10,000 to buy a stock that has no worth less initial credit received $1,000 - loss of $9,000

The numbers wont always work out exactly like that, but at least you get the general idea.
There are heaps of posts here clarifying this...they're more reliable than mine 

Consider the vertical spreads Mofra mentions. There are also wingspreads and time spreads which can be used to make income. All of which use far less collateral/margin that naked puts or covered call strategies.


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## >Apocalypto< (9 July 2008)

MRC & CO

Is that your pic in the Avatar? 

*

Trading naked options is a great way to ruin yourself.*


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## MRC & Co (9 July 2008)

>Apocalypto< said:


> MRC & CO
> 
> Is that your pic in the Avatar?
> 
> ...




Yeh, it's me.  Why is that?

Yeh, I see what you mean mazzatelli1000, however, the big difference for me is, the stock is not likely to go bankrupt if you are buying a blue chip.

If you sell a naked put, and the price falls, you HAVE to pay the difference.  If you sell a covered call, and the price falls, you won't be exercised and you can hold.  Say BHP for example, it is not going to go bankrupt, will just experience swings, so I know where I would rather be placing my money if I write a strike of 50, it now falls to 30 in 3 months and the option expires.  Would rather the call any day of the week.

But again, then you become an 'investor'.  

Vertical spreads look like the strategy I would prefer in a trending market (not the environment currently).  Ratio spreads is another I looked at.  But I find the market complex and confusing enough, without having to take into account 5 greeks  

May move to options one day, but for now, hedging equities (my version of low risk and hedging against direction) and then intraday futures (which I sometimes do, but plan to do it consistently down the track).  

Cheers


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## wayneL (9 July 2008)

MRC & Co said:


> Yeh, I see what you mean mazzatelli1000, however, the big difference for me is, the stock is not likely to go bankrupt if you are buying a blue chip.
> 
> If you sell a naked put, and the price falls, you HAVE to pay the difference.  If you sell a covered call, and the price falls, you won't be exercised and you can hold.  Say BHP for example, it is not going to go bankrupt, will just experience swings, so I know where I would rather be placing my money if I write a strike of 50, it now falls to 30 in 3 months and the option expires.  Would rather the call any day of the week.
> 
> But again, then you become an 'investor'.




The difference is strictly philosophical (and a bit of capital).

If you own a blue already and don't intend to sell, CC it (when appropriate) to buggery. It's a no brainer.

If however you don't already own the share and looking to take a quick scoop of option premium, whether or not you want to eventually own the share, puts make more sense... or a combination of the two.

But in line with other comments, spreading may be better again... and a lot more flexible in what you can achieve.

One more controversial statement. Naked calls and puts are less risky than the equivalent share position. (pure risk, not R/R)


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## juw177 (9 July 2008)

And the other thing vs owning the stock is you have to find a buyer / seller in this illiquid options market, so you are going to lose from slippage.


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## MRC & Co (9 July 2008)

Agreed Wayne.

It all comes down to what you are trying to achieve.  But in the original post, naked puts would just be WAY too risky.

I think he would be more after a credit spread (though which ones in this market...............I wouldn't even begin to try and guess, unless it was a bear call LEAP spread)!

I also agree, naked calls and puts and their risks are MASSIVELY over-rated for those who are willing to simply buy and hold the equivalent shares.


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## wayneL (9 July 2008)

MRC & Co said:


> I also agree, naked calls and puts and their risks are MASSIVELY over-rated for those who are willing to simply buy and hold the equivalent shares.



What some people do is sell dozens of contracts WOTM, oblivious to the MASSIVE gamma and potential delta they are taking on.

This is where the perception of outlandish risk comes from, and they'd be right in this case.


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## MRC & Co (9 July 2008)

LOL    Some people


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## wayneL (9 July 2008)

MRC & Co said:


> LOL  :  Some people



You'd be surprised!


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## Mofra (10 July 2008)

MRC & Co said:


> If you sell a covered call, and the price falls, you won't be exercised and you can hold.  Say BHP for example, it is not going to go bankrupt, will just experience swings, so I know where I would rather be placing my money if I write a strike of 50, it now falls to 30 in 3 months and the option expires.  Would rather the call any day of the week.



How many HIH covered callers may have thought of the same thing? 

You also have to factor in opportunity cost when you consider a covered call/naked put. For example, CBA at $62 may have been paying (for example) $0.70 for a 1 month strike at $63 ($1 out of the money). A Buy & Write may have given you an instant 1.1% return, however you would currently have a theoretical loss of 33.8% (gross, adjusted for option premium) based on CBA's current price of $40.55 which now requires a return of 53.6% just to get to breakeven.

That's _without_ factoring in the opportunity cost.


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## MRC & Co (10 July 2008)

Yep, no disagreement there.

But if you were a long-term holder, what opportunity cost do you miss out on?  You were holding the same stock anyways, so at least your loss is marginally smaller due to the addition of the premium.

You really only loose if the stock moves above strike + premium, but that is the trade-off as we all know.  No trade will always give you an outright benefit without a negative.


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## mazzatelli1000 (11 July 2008)

MRC & Co said:


> Yep, no disagreement there.
> 
> But if you were a long-term holder, what opportunity cost do you miss out on?  You were holding the same stock anyways, so at least your loss is marginally smaller due to the addition of the premium.
> 
> You really only loose if the stock moves above strike + premium, but that is the trade-off as we all know.  No trade will always give you an outright benefit without a negative.




Covered Call stock at $10. Falls to $8. Received premium for one month $1.
Overall loss = $1. Now you can sell calls to get back some premium still.

Naked Put sold at strike $10. Stock falls to $8. You are exercised - $2 loss. Initally received $1 credit. So now net loss of $1. Now you own the shares. Now you can sell calls to get back some premium.

Eventually its close to the same thing money wise. In the end you still purchased the share for $10.
I think it was nailed earlier - the perceived difference is psychological.


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## MRC & Co (11 July 2008)

^^^^^^^^^^^^^

Yep.


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