Selling an option creates an the obligation of the seller to provide the option buyer with the underlying shares or futures contract for a corresponding long position for a call option or the cash necessary for a corresponding short position for a put option at expiration. If the seller has no ownership of the underlying asset or the corresponding cash necessary for execution of a put option, then the seller will need to acquire it at expiration based on current market prices. With no protection from the price volatility, such positions are considered highly vulnerable to loss and thus referred to as uncovered, or more colloquially, as naked. Naked options are attractive to traders and investors because they have the expected volatility built into the price.
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Welcome to the 1rd lesson in the " Option Trading Tactics Bootcamp " series. Here we cover the most important trading rules new option traders should follow. Trading losses are unavoidable. Sometimes the market doesn't cooperate with you. But other times there are stupid trading losses, like holding onto a loser or averaging down into a losing trade, where the addition of risk wasn't planned. I believe that the biggest losses come not from a bad market call, but from stupid trading mistakes. If you can eliminate these mistakes and focus on controlling your risk, you will see that the rewards start to "magically" appear in your account.
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As investors become more educated and savvy, they look for new and exciting ways to trade the markets. This often leads investors to seek out the concept of selling naked options. What does it mean to trade options naked? It doesn't mean they are trading from a European beach somewhere getting a line-free tan, but rather, the trader is selling options without having a position in the underlying instrument. For example, if one is writing naked calls , they are selling calls without owning the underlying stock.
We are in another round of quarterly earnings and that means implied volatility levels and option prices will rise. If you fancy selling premium like an investor selling cash-secured puts, you may be salivating a little more. However, it can be dangerous especially for new option traders and should be left for more advanced option traders and those with large trading accounts. Short-option premium can seem like an easy way to make a profit in trading. What traders forget is that the premium received from selling options is not theirs to keep until the position is closed for a profit or it expires worthless.