SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Naked Options: Redefining High Risk


Most options traders are aware of the definition of risk for strategies. For example, a covered call is low-risk and an uncovered call is high-risk.  While not recommending that everyone run out and open uncovered call options, a point worth making is that these “universal” definitions are not always reliable.

There are times, for example, when uncovered calls are not as high-risk as they are at other times. Risk itself is a variable, and some conditions invite a reevaluation of the risk picture.

Consider the case of Netflix as of January 26, 2018. The company reported huge growth in the fourth quarter, 2017 in subscribers, both domestically and internationally. The stock price jumped about 30 points on January 23 and ended up above the upper Bollinger Band. (When prices move above this level, which is two standard deviations above the middle price, the expectation is that price will return to the range below upper band, usually very quickly.

However, the price remained above upper band for four sessions. By January 26, price had risen above $269, or 48 points higher than price levels only five days earlier. During the past six months, price had gone above on occasion, but never stayed there for this long.

With this unusual situation in mind, a retracement of price is very likely. This forecast is confirmed by the highlighted volume spike on January 23 and by Relative Strength Index (RSI), revealing the index on January 26 at 88.74, or 18.74 points above the overbought level of 70.

These signals predict a price decline, and with that in mind, many traders would look at long puts. For example, as of January 26 about 30 minutes into the trading day, with price at $269.57, the 7-day 270 put was at an ask of 6.25. Assuming a $5 trading fee, buying this long put will cost about $630, and breakeven is $263.70. With only one week to go, time decay will be rapid. In fact, on average, options expiring in one week tend to lose 34% of remaining time value between Friday and Monday. The long put is of questionable value.

 

            image.png

 

In comparison, an uncovered call option expiring in one week at the strike price of 275 could be sold at a bid of 370, netting about $365. The risk here is that the price will continue rising and the call could end up in the money. But with a five-point buffer between current price and the uncovered call’s strike, the risk level is quite low. Adding the $365 premium, total buffer zone is about 8.65 points. And time decay will be falling rapidly over the week.

With the technical signals supporting a high likelihood of retracement, what are the chances that this stock price will rise another five points? Just based on the price above upper Bollinger Band, it is very unlikely. Adding in the volume spike and excessively high index of momentum (RSI), the uncovered call does not look especially risky. Further confirmation was seen in the candlesticks for the last two days. The white session is followed by the latest day opening higher and retreating to within the range of the previous day. This forms a bearish piercing lines signal (also called a dark cloud cover). By itself, this is not significant; but as a confirmation of the rest of the bearish retracement signals, it only adds strength to the forecast.

Uncovered calls are high risk trades, without any doubt. But they are the highest risk when opened at the money; following a price decline; or when the underlying is exceptionally volatile. In the situation for Netflix, the unusual attribute of the stock price was the huge jump in a single day, gaping above the upper Bollinger Band. Alternatives to shorting calls include bearish vertical spreads, synthetic short stock, or calendar spreads. In other words, there are plenty of ways to trade a bearish situation, even one that is short-term in nature.

One final note: In opening an uncovered call, you are required to post collateral in your margin account equal to 20% of the strike value, minus premium received. In the example of a 275 short call, 20% is $5,500. A free margin calculator is provided by the CBOE and can be downloaded at
http://www.cboe.com/trading-tools/calculators/margin-calculator
 

Michael C. Thomsett is a widely published author with over 80 business and investing books, including the best-selling Getting Started in Options, coming out in its 10th edition later this year. He also wrote the recently released The Mathematics of Options. Thomsett is a frequent speaker at trade shows and blogs on his website at Thomsett Publishing as well as on Seeking Alpha, LinkedIn, Twitter and Facebook.

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • Expiration Short Strategies

    Some traders have entered the options arena by selling exceptionally long-term contracts. The rationale for this is based on dollar amounts. A 24-month contract may yield an impressive dollar amount, but is it the best net return? It is not.

    By Michael C. Thomsett,

    • 0 comments
    • 128 views
  • Should You Finance or Pay Cash for a Home?

    When buying a home, individuals who have accumulated enough wealth to pay cash or make a substantial down payment have a decision to make. Take advantage of record low interest rates and lock in a 30-year mortgage for around 2.5%? Or pay cash and make payments to yourself by investing the savings?

    By Jesse,

    • 0 comments
    • 135 views
  • Implied Volatility Collapse

    The key ingredient on expiration Friday is volatility collapse. At the beginning of that last trading day, there are more than 6 hours of trading yet to go. However, there are 38 hours left before expiration on Saturday. When volatility is high, OTM options are most likely to be overpriced.

    By Michael C. Thomsett,

    • 0 comments
    • 233 views
  • Trading Volatility: Why It Isn’t Always a Bad Thing

    Volatility is still widely misunderstood — and feared — by novice traders. As someone lacking in trading knowledge and experience, you often hear and believe horror stories of unstable markets. The fear is valid. After all, your shares and investments are at an elevated risk in an unpredictable environment.

    By Kim,

    • 0 comments
    • 208 views
  • Models and their limits

    Options traders tend to think mathematically. When considering selection of an underlying, risks and expected profits, the model of outcomes is a primary tool for making selections. Without a model how can anyone understand the differences between two or more options that might otherwise appear the same – similar moneyness, same strike, and same premium.

    By Michael C. Thomsett,

    • 0 comments
    • 212 views
  • When You've Only Got $1000 To Invest, What Do You Do?

    Are you new to the world of investments? Most likely; it’s not something you just fall into! BUt at the same time, investing can be done by anyone. Investing doesn’t need to be saved for retirement. It isn’t something only the uber rich are able to get into.

    By Kim,

    • 0 comments
    • 454 views
  • Use of Options Spreads to Reduce Risk

    Traders may view spreads as a means for reducing market risk. But this also means that the potential profit is just as limited as potential loss, and this is easily overlooked in the focus on risk alone. A realistic view of spreading is that it reduces risk in exchange for accepting limited maximum profit.

    By Michael C. Thomsett,

    • 0 comments
    • 524 views
  • Put Writing in 2020: The Role of Timing Luck

    The impact of luck can play a meaningful role in the short-term outcomes of monthly option trades due to the requirement to roll expiring contracts. The extreme volatility in 2020 highlightsthis fact when we look at results of SPY cash secured put trades launched on slightly different start dates.

    By Jesse,

    • 0 comments
    • 507 views
  • The problem of Option Math

    Option traders may be divided into two categories. First are those relying on instinct or casual observation. This group tends to speculate on directional movement, future volatility, value, and on potential profitability of trades. The second group is involved deeply with math of trading and depends on what is perceived as certainty or near certainty.

    By Michael C. Thomsett,

    • 0 comments
    • 682 views
  • Put/Call Parity: Two Definitions

    Traders hear the term put/call parity a lot, but what does it mean? There are two definitions and they are vastly different from one another. The first definition involves the net credit/debit for any combination trade, with trading costs are considered. The second definition takes assumed interest rates and present value into mind.

    By Michael C. Thomsett,

    • 0 comments
    • 573 views

  Report Article

We want to hear from you!


There are no comments to display.



Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs Expertido