Critical Options Investing Tip When Trading Naked Calls and Puts

An option is a derivative trading product that is best used by investors as a hedging tool providing investing profit protection and profit enhancement. Although it is a powerful risk management tool, it can also be used effectively as a stand-alone trading vehicle.

Under the proper conditions, options do not have to be paired with stock or another option to be an effective trading tool. When investing, to successfully trade naked options, an investor must realize that certain options will fit certain scenarios and certain options will not.

One of the major misconceptions that investors have about investing in options stems from the fact that most do not know how to trade them properly. When they lose money trading them, they feel that there is something wrong with the option. They do not understand that options are on a higher, more sophisticated level when compared to stocks.

Stock trading has fewer variables involved and is therefore easier. No one is saying that the individual investor isn’t smart enough to invest in trade options. The problem is not intelligence; it’s just education and experience. Most investors have not been properly educated in the proper use of investing options, and even fewer have had any real experience trading them.

One of the biggest problems investors have is this: While investing and even if you buy a call and the stock goes up, you can still lose money. Most investors tend to buy out of the money options at a cheap price. The stock trades up a little, which is the right direction, but the option still loses money and the investor wonders why.

What the investor fails to realize is that in order for the option to be profitable the options delta must out-pace its rate of decay. Implied volatility also plays a key role if the stock does trade up while implied volatility decreases, the options delta must then outperform the decrease in volatility. Remember, when volatility increases, the price of all options goes up. When volatility decreases, the price of all options goes down.

We have categorized options in several ways. One way is by the option’s strike price, and its distance from the stock price. We identified these options as either in-the-money, at-the-money, or out-of-the-money.

In our discussion about trading naked calls and puts, we will identify trading opportunities or situations that fit each of these types of options, for both calls and puts. But it is important to first review the definition of Delta before continuing.

Remember, delta tells you how much the option will move with a similar move in the stock and is given as a percentage. For example, a 33 delta option means that the option will move 33% of the movement of the stock and 70 delta option will move 70%. In-the-money options act like stock. The deeper in the money the calls are, the more they act like the stock. As the call moves deeper and deeper in the money, the calls delta approaches 100 which means it’s price movement will reflect 100% of the stock’s movement. (This is discussed in more detail later in The Stock Replacement Covered Call Strategy).

In fact, deep-in-the-money options are sometimes even used to replace stock positions. If you look at the charts below, you can see how closely the in-the-money call mimics the upward movement of the stock (2nd quadrant).

View Graphic

In the money options are best used for smaller stock movements. The reason is that in-the-money options contain less extrinsic value. The extrinsic value can work against you when purchasing an option because extrinsic value is affected by time decay.

As you wait for your stock movement, the in-the-money option will decay less than either the at-the-money or out-of-the-money options because it has less extrinsic value. The amount of money you lose in time decay must then be made back by additional stock movement.

Obviously, the less you lose in decay, the less the stock has to move for you to be profitable because it has less decay loss to make up for.

This is because an in-the-money call has a high delta and a much higher percentage chance of finishing in-the-money by expiration so they follow the stock more closely.

With less extrinsic value loss in the options investing to make up for, a smaller movement in the stock will produce a greater profit. For a call example, as you can see in the chart below, the in-the-money produces a profit with the least amount of stock movement. With less extrinsic value, the ITM option has a lower break-even point.

For chart below, stock price = $35.00 Strike Option Delta Breakeven Extrinsic Price Price Value

$30 5.20 85 35.20 $.20 $35 1.00 52 36.00 $1.00 $40 .30 20 40.30 $.30

-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-
If You Would Like to Learn More About Investing
Responsibilities Then Discover How to Protect Your Investments
With the Leveraged Power of options & Learn How to Trade Options
Like the Pros..

Click Here --> http://www.options-university.org
-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-

---

Planning for Retirement

Almost without exception, people don't start planning for their retirement... Read More

The Perfect Mutual Fund

The Perfect Mutual Fund is the one you build yourself!The... Read More

Wit and Wisdom on Money, Wall Street and Success - Part #2

Here are ten more WISDOM packed GEMS that ooffer very... Read More

Find Your Investing Soulmate on the Jersey Turnpike

As a followup to a previous column, "Irreconcilable Differences," I... Read More

Press Release Scams and Successes: Reading Between the Lines

Press releases are a means through which companies can keep... Read More

Stock Market Leaders and Laggards

Leaders are stocks that breakout immediately when the market confirms... Read More

Investing: Do You Want To Make Money, Or Would You Rather Fool Around?

It always amazes me how much stock market investors resemble... Read More

How To Find An Investment Advisor

Do you think you need an Investment Advisor? Hold on... Read More

Invest or be Pink Slipped

Firing an employee seems to be easier and easier for... Read More

The Realities Of Market Timing

Market timing systems are based on patterns of activity in... Read More

Powerful Options Basics Lessons Improving your trading in 180 days.

An option is a traded security that is a derivative... Read More

DXPortfolio: A Great Passive Investment of 25% to $40% per month

First, I need to explain about e-currencies or digital currencies.... Read More

Economic Survival in the 21st Century - the Three Key Questions to Ask

In this "special report", I want to pose a few... Read More

When It Comes To Investing, Asking The Right Questions Can Help You Make The Right Decisions

Are you ready to open your pathway to financial independence?Well... Read More

Retirement Is A Scary Proposition If Youre Without A Plan, And Running Out Of Time

Of the 75 million baby boomers nearing retirement today, many... Read More

Gold and Silver Maple Leafs Get New Packaging

Gold Maple Leafs and Silver Maple Leafs are receiving packaging... Read More

Have Analysts Gotten Honest?

It caught my attention when I heard an analyst on... Read More

Help with My Annuity

The cries are heard from the distance, "I need help... Read More

Critical Investors Business Daily Responsibilities - If not Followed Could Cost You Millions!

When thinking about the investors business daily responsibilities in today’s... Read More

The Past Does Not Equal The Future: Mutual Fund Returns!

A way that investors get ripped off and in a... Read More

Oil and Gasoline Price Uncertainties

The Light Crude Continuous Contract hit an all-time high at... Read More

Rules for Simplified Employee Pension Plans better known as a SEP Plans

A SEP is a special type of IRA. Under a... Read More

Investing In Sons Business Could Cause A Real Family Feud

Q: My youngest son wants to borrow $5,000 to start... Read More

Critical Options Investing Tip When Trading Naked Calls and Puts

An option is a derivative trading product that is best... Read More

Trading Systems

A trading system consists of a set of rules for... Read More

25 Ways to Find Companies to Buy

When you start your program to purchase your "ideal" company,... Read More

Is Starting A Business For Me? What To Consider Before Starting A Business

Do you have the right temperament?Starting a small business is... Read More

Buying a Home - Your BIGGEST Investment

This column has often focused on intangible investments like stocks... Read More

Retirement ? Its Sooner Than You Think!! (Honestly)

Many people hear "retirement" and think- what? 401K? Roth vs.... Read More

Bearish or Bullish?

If you are interested in stock investing and the stock... Read More

Lessons in Transition

Q: What have been the most successful approaches to attracting... Read More

Chinas Inscrutable Currency Strategy

Purpose: Expose Opportunities for Smart InvestorsThe move by China's central... Read More

It?s Not the Size of Your Bank Account

You might think that if you win the lottery or... Read More