Weekly Option Trader

Since options decay as time passes, selling them has an advantage.  Every day that passes, including weekends and holidays, lowers their value.  Since the goal in selling options is to buy them back lower, having the certainty of time’s passing is a great ally.

Selling uncovered or “Naked” Calls has theoretical unlimited risk.  Call option sellers, or writers as they are also known, obligate themselves to deliver a stock at a set price no matter how high the market goes.  The seller of a Covered Call doesn’t have market risk of a runaway stock, because they can deliver out of their own inventory.

Selling Naked Puts obligates the sellers to buy the stock at the strike price if the buyer of the Put chooses to exercise their right.  In a sense, writing a Put is like writing an insurance policy.  If the stock crashes, it crashes on the insurance company, the Put seller.

Selling options can be played two ways.  First, you can sell them with the intent of buying them back later for less.   The basic buy low/sell high, albeit in reverse order.  Or you can sell them and hope they expire worthless for the person who bought them.  Sell high without ever having to buy.  Question:  Is it Infinite Return Investing when you profit from things without a cost basis?

Naked Puts have the same risk characteristics as Covered Calls.  Basically if the stock price closes below the strike price, the writer of either option will own the stock.  On the Covered Call, they will own the stock because they won’t be called out.  The writer of the Naked Put would own the stock because it would be Put to him.

On the same token; if the stock price is above the strike price, both option writers would NOT own the stock.  The Covered Call writer would be called out, while the Naked Put seller would have stock assigned to them.

The Put premiums should almost equal the Call premiums.  Their only true difference should work out to the Interest Rate and/or Dividend calculations.

Margin

A big advantage to selling Put options is the lower margin requirements.  When you buy a stock, whether you write Covered Calls or not, you have to pay for it.  You may be able to buy it on margin.  Typically margin works this way; your broker will loan you 50% of the value of a stock.  They’ll use stock as the collateral for the loan.  Interest rates vary from broker to broker.

If the stock increases in value, your broker will let you borrow additional sums.  But if the stock price drops, the broker may ask for more money.  Generally, they want to have at least 35% equity.  Any less than that will cause a house call or margin call.

Margin calls are not phone calls you want to receive.  If you can’t come up with the extra money to bring your account to the minimum requirements, your broker has the right to sell your position off at a loss to you.  There’s nothing you can do but turn an unrealized loss into a realized one.  You ‘re obligated to give them security or pay them their money.

Margin also measures security.  When allowing Naked Put selling, brokers will require a certain amount of good faith money.  This is also known as margin.  Typically the margin requirements for selling Naked Puts will be 50% lower than buying stock.  It works out to around 25% of the value compared to 50%.  Since it only takes a small fraction of the price to obligate oneself to buy it, only more experienced traders should consider selling uncovered options.

Margins can and do change, often dramatically.  Brokers typically want a minimum 25% of the strike price before allowing Put writing.  Some will allow you to subtract the amount Out of The Money (OTM) on the option.  Example: a $50 Put on a $55 stock is Out of The Money by $5.  The margin required to write this Put would be $7.50.  One fourth of the $50 strike equals $12.50, minus the $5 OTM totals $7.50.  If the stock were to drop, the margin required would increase.  A $50 Put on a $53 stock equals $9.50, $12.50 less the $3 OTM.  If the stock dropped another $5 down to $48, the margin would increase to $14.50.

A One Dollar drop in the stock raises the margin requirement by the same dollar.  A Five Dollar move on a $50 dollar stock equals 10%, but the margin could move by 50% or more.

Either start with a lot of money or be prepared for margin calls.  For that matter, only consider Naked Puts with your excess money.  Cash lying around in accounts doesn’t provide income like selling Puts can.  But solely selling Puts can tie up money that could be used better buying options.