The riskiest options trading strategy known to man

Today, I wanted to discuss the riskiest options trading strategy known to man. I’m going to go over the strategy and then I’ll give you the names of two other strategies that you’ll want to stay away from because each of them is using risky trading within the strategy. Then let’s get started.

The option trading strategy with the highest risk for an investor is known as naked call selling or a short call. The operation of this strategy is as follows:

1. Find a stock that you think will not have much upside or volatility, also known as SPECULATION. This should be your first indication that this strategy should not be used.
2. You sell a naked call option (this means that you do not own the shares, but agree to sell these specific shares in the future at a predetermined price).
3. You receive a premium (meaning someone is paying you to have the right to buy the underlying shares, which you don’t currently own, from you at some point in the future).
4. Now, this is where this strategy can get UGLY! READ BELOW

Selling naked calls (a short call) is gambling. You receive a premium from an investor that gives them the right to buy from the market or from you, whoever is cheaper. Consider the following example.

You sell one (1) naked call on ABC stock at a strike price of $20. The buyer of your naked call pays you $3. (Ok, you just won $3 per contract, or $300.00)*
The current market price of the stock is $15.

Sounds good so far, huh? You have $300 and the stock would have to move from $15 to over $23 ($20 strike price plus the $3 premium) before the person with the call option comes to you and makes you buy the shares. shares at market price and sell them to you. for $20 Well, just to let you know, because there is no limit to how high the stock price can go, your risk is UNLIMITED!

Let’s say you wake up one morning three weeks in the future to find that the stock that was trading at $15 when you sold the naked call is up $50 a share. Well, guess what the person who bought you the call is doing? He’s outside knocking on your door asking you to sell him the shares for $20, so he can sell them on the market for $65. What an ugly situation you find yourself in now. You have to buy the stock at $65 and turn around and give it up at $20, leaving you with a loss of $42. (Your cost of $65 minus what you sold for $20 equals $45. But remember, you’ve already been paid $3, so your loss is $43 per share or $4300.00) OUCH!

Now granted, this is an extreme example, but it’s best to stay away from selling naked calls so you don’t end up on the wrong end of a runaway action while you were sleeping. Get my drift.

Well I hope you understand the risk involved in selling naked calls now, here are two other options trading strategies to avoid like the plague:

short straddle: a short call and a short sale
short combination: a short call option and a short put option (the combination will have different strike prices, i.e. sell a 20 call and sell a 30 put)

* One (1) contract equals 100 shares, so if you receive $3 per contract, you will receive $300.00 as a premium.