Going Naked Has Its Place, Just Not in Options

I don't like trading opens stand alone, outright, or as it's sometimes called, naked.

The problem with buying options outright is that you can get the direction right and still lose money. That's because time decay works against you. I often lecture on trading options in three dimensions, with only one of them being direction. That's the What. The other two dimensions being time, the When, and Velocity, the how fast.

You can be right on the what, be wrong on the other two and lose money. Let's say you're bearish on Google (GOOG), now trading at 1142. You think it will be 1100 by the February expiration and you buy the Feb 1100 put. And, you're right, it goes to 1100 but it goes there very slowly. Don't forget, the 1100 put is still worthless at expiration with GOOG at 1100.

It's far better to trade in the form of a spread. Let's say you buy the 1100-900 vertical put spread. Your entry level price is much reduced, which acts as a buffer. Now, a vertical spread will cap your profits as the 1100-900 put spread can never be worth more than 20. But, hey, that's how trading works. You cap your risk means capping your reward.

Speaking of capping your risk, selling options outright, or naked, means an unlimited risk exposure. With the maximum reward being the premium you collect. I never advise taking on any position with unlimited risk exposure. So, once again, trade in the form of a spread.

Let's say you think GOOG will stay right around 1140 until expiration. You can sell the february 1140 straddle naked at 73, or $7300 per straddle. Admittedly, that's a lot of money. But, that's all you can make and your risk is unlimited.

So, if you buy the Feb 1220 call at 10 and the Feb 1020 put at 5 (the strangle at 15), you make 58, $5800, instead, but your risk is capped.

In conclusion, while we all like being naked now and again, being naked in options trading is not the way to be.

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