We share the riskiest options trading strategy and why we avoid selling naked Calls like the plague. It's a trade that can lose you everything.
What Is a Naked Call Option?
Naked Call is a short Call strategy without owning 100 stocks in the first place. It is a bearish strategy that becomes profitable if the stock price does not rise.
A short OTM Call option earns a premium upfront. The Call value depreciates if the stock price stays below the strike price before the option expires. Then the strategy earns a profit.
Maximum profit = premium
If the option value expires worthless, the maximum profit of selling a naked Call is the premium.
If the stock price increases beyond the strike price before expiration, we will be forced to sell 100 shares. But the naked Call strategy usually means we don't own 100 shares to sell, so we would be forced to buy to close the Call option for a loss.
Loss = 100 x (stock price - strike price) - premium
Maximum loss = infinite
The loss is calculated as 100 times the difference between the stock price and the strike price. If unfortunately, the stock price keeps going up, the maximum loss can be infinite.
Benefits of Selling Naked Calls
There are a few advantages of selling naked Calls:
- Naked Calls can generate steady income from the premium.
- It can be profitable even if the stock price stays neutral.
So we can continue to sell naked Calls if we feel the stock price is overvalued.
Why We Never Sell Naked Calls
There are a few risks in trading naked Call options:
- If the account does not own 100 shares upon assignment, then we usually need to close the trade for a loss.
- The strategy doesn't limit the maximum loss. If the stock price keeps going up, you can lose everything over a single trade.
So most trading platforms don't let newbies sell naked Calls, and most options experts don't recommend this options strategy.
Strategies for Selling Naked Calls
The naked Call strategy is suitable for bearish stocks. So we prefer to use the Bear Call Spread screener to find overvalued stocks with a bearish technical outlook. We pay special attention to stocks with a negative Upside right now too. So we can find a list of stocks that have a high probability of going down.
Best Stocks for Selling Naked Call Options
Once we filter the US stocks to find overvalued opportunities, we can choose our favourite stocks to sell naked Calls.
The most overvalued bearish stock right now is IDXX. So we can sell a Call contract at around 20 delta that expires next month. Then we can make a profit if the stock price stays low. But if the stock price rises sharply before expiration, our loss would be 100 times the difference between the market price and the strike price.
Better Alternative to Naked Calls
Even though the naked Call is a simple bearish strategy to use, we still worry about the potential risk of unlimited losses.
So we recommend the Bearish Call Credit Spread to use the least amount of buying power for a bearish trade, while also limiting the maximum losses. Sometimes you may find returns of more than 100%.
Now you know selling naked Calls exposes you to unlimited risks, you can try selling Bear Call Spreads to profit from a bearish market.
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