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Option Risks - Basics


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Option Risks - Basics

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  #1 (permalink)
 bchip 
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Hi all

I'm just trying to understand the basics of all the risks relating to options.

If I buy a put or a call I understand the the most I can lose is the premium.
Nothing else much.

When it comes to selling a naked put or call though, Im a bit unsure.
I take it the loss is the difference between whats going on at market & the exercise point
If it doesnt get exercised then again, no risk.

In the event it does get exercised (the holder made the right call)
So if I sold 1 call at $100 for ABC, halfway before expiry the person exercises the option @ 110
so $-10 loss*100 = $ -1000 will be taken from my account.

It looks like TD Ameritrade withholds 10% of total exposure (from what I can see in ToS, hope I'm right with this).
So $100 per share*100 = $10,000 * 10% --> means $1000 will be required for margin.

As this trade is now closed with it being exercised the holder gained $1000, I lost $1000
and that's the full trade.

The big risk with the nakeds is that if you dont have the money and go in to big
Something like a covered call basically means you dont really deal with gearing so its low risk

I.e. if things started to go really wrong, you could hedge your position with either a call/put
or by buying the underlying stock. Which meant your ok as it implies your not really over exposed to your position?

Am I understanding this all right?
Advice appreciated

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  #2 (permalink)
 Silver Dragon 
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bchip View Post
Hi all

I'm just trying to understand the basics of all the risks relating to options.

If I buy a put or a call I understand the the most I can lose is the premium.
Nothing else much.

When it comes to selling a naked put or call though, Im a bit unsure.
I take it the loss is the difference between whats going on at market & the exercise point
If it doesnt get exercised then again, no risk.

In the event it does get exercised (the holder made the right call)
So if I sold 1 call at $100 for ABC, halfway before expiry the person exercises the option @ 110
so $-10 loss*100 = $ -1000 will be taken from my account.

It looks like TD Ameritrade withholds 10% of total exposure (from what I can see in ToS, hope I'm right with this).
So $100 per share*100 = $10,000 * 10% --> means $1000 will be required for margin.

As this trade is now closed with it being exercised the holder gained $1000, I lost $1000
and that's the full trade.

The big risk with the nakeds is that if you dont have the money and go in to big
Something like a covered call basically means you dont really deal with gearing so its low risk

I.e. if things started to go really wrong, you could hedge your position with either a call/put
or by buying the underlying stock. Which meant your ok as it implies your not really over exposed to your position?

Am I understanding this all right?
Advice appreciated

Hi @bchip

I would suggest starting here: Tasty Trade Learning Center They have a ton of info and videos to walk you through everything you want to know.

If your interested in learning how to trade options I would suggest Tasty Trades Where Do I Start video series which can be found here: Where Do I Start? Options 101

Robert

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  #3 (permalink)
 bchip 
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I tried it now HYG trading @ 84 ask for $1,500 ... ~ 18%


MSFT - trading @ 206 asks for $2,700 ...~13%


KO @ 49 asks for $862 ....so 20%



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  #4 (permalink)
 SMCJB 
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bchip View Post
Hi all

I'm just trying to understand the basics of all the risks relating to options.

If I buy a put or a call I understand the the most I can lose is the premium.
Nothing else much.

When it comes to selling a naked put or call though, Im a bit unsure.
I take it the loss is the difference between whats going on at market & the exercise point
If it doesnt get exercised then again, no risk.

In the event it does get exercised (the holder made the right call)
So if I sold 1 call at $100 for ABC, halfway before expiry the person exercises the option @ 110
so $-10 loss*100 = $ -1000 will be taken from my account.

It looks like TD Ameritrade withholds 10% of total exposure (from what I can see in ToS, hope I'm right with this).
So $100 per share*100 = $10,000 * 10% --> means $1000 will be required for margin.

As this trade is now closed with it being exercised the holder gained $1000, I lost $1000
and that's the full trade.

Your confusing "RISK" with "OUTCOME".

When it comes to options and "RISK" their are three main risks (and one of them is actually quite minor)
- Price Risk (expressed as an options Delta and Gamma)
- Volatility Risk (expressed as an options Vega)
- Interest Rate Risk (expressed as an options Rho) - the minor one, unless you are trading very long dated options.

When you buy an option you have unlimited upside and limited downside.
When you sell an option you have limited upside and unlimited downside.


bchip View Post
The big risk with the nakeds is that if you dont have the money and go in to big
Something like a covered call basically means you dont really deal with gearing so its low risk

A covered call is exactly the same as a short put. You are still short an option and your downside is unlimited. Don't think it can go below zero? Look at May20 Crude Oil!


bchip View Post
I.e. if things started to go really wrong, you could hedge your position with either a call/put
or by buying the underlying stock. Which meant your ok as it implies your not really over exposed to your position?

Trading Advice. If it goes wrong, just get out. Nobody wants to take the loss but over complicating the trade by adding a dirty hedge often makes things worse, not better.

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 jokertrader 
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I second the last comment. If u are in a naked option, better to sell straddle/strangle when vol is high and get out at a predetermined level. Otherwise u could spend many wasted trades. After years of trying different things I have concluded that I like defined risk most times - doesn’t mean it has to be a simple call or put (think different types of butterflies) ... like was mentioned good place is tastytrade and optionalpha for free decent education


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 myrrdin 
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In case you prefer reading books to learn the basics of option buying and selling, there a many of them.

I like recommending the books of Carley Garner. She gives all information you need, and the books are easy to read.

I also use the book of Lawrence McMillan: Options as a strategic investment. (He has written other books, too.) He goes more into details, and the book is not as easy to read as Carleys book.


Many traders of short options take a lot of effort to find the best place to get into the trade, but do not care as much about getting out. In very short words: If the trade is successful, I will get out, taking 50 to 80 % of maximum profit. The last couple of days of a trade are the most "dangerous" because of gamma risk. If the trade is not successful, I do not want to loose much more than 100 % of the original price. The reason behind: If you you loose 5 times your potential profit, you will need 6 to 8 perfect trades to recover (depending on where you take profit). And you still have not made any profit.

You find much more information on this topic in this thread and in the thread "Diversified Option Selling Portfolio".

Best regards, Myrrdin

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 SMCJB 
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myrrdin View Post
Many traders of short options take a lot of effort to find the best place to get into the trade, but do not care as much about getting out. In very short words: If the trade is successful, I will get out, taking 50 to 80 % of maximum profit. The last couple of days of a trade are the most "dangerous" because of gamma risk. If the trade is not successful, I do not want to loose much more than 100 % of the original price.

Sound advice. Don't be greedy. Take your profits and move on.

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