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
-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-

---

Investing Online Has Its Rewards: Find Out How To Take Advantage Of Them

Computerized investing. Online investing. Have you taken the next step... Read More

Trading Baskets Part I

Q. What is a basket?A basket is a group of... Read More

Success Trading for New Traders: What Does Bid and Ask Mean?

Do you ever wonder exactly what's going on in the... Read More

Powerful Hidden Techniques Mystery Formula - The Covered Call Option Trading Buy-Write Strategy

For better or worse, most option trading investors purchase stocks... Read More

Investing in New Zealand - Learn how to Find Unique Investment Opportunities

Investing in New Zealand might be much easier than investing... Read More

The Biggest Oil Opportunity in the World ? And How You Can Profit From It

Where is the second biggest deposit of oil reserves in... Read More

Stock Market Retirement Investment Plan

For a successful retirement investment plan to work in the... Read More

Why the Rich Keep Getting Richer

Rich people: fortunate, lucky, selfish, and arrogant? Or highly educated,... Read More

Easily Finding A Good Stock

There is a tremendous amount of software, complicated high priced... Read More

Stocks, Oil, and Bonds

A barrel of oil bounced to over $60 Thu, which... Read More

Tyranosaurus Rex

Everyone knows T Rex was the most fearsome of all... Read More

Success Trading: More Basic Terminology for New Traders

One important aspect of trading the markets is to understand... Read More

Invisible Mutual Fund Fees Erode Your Returns!

Many investors think that investing in mutual funds is free.... Read More

Variable Annuities

You know all the articles you read about annuities that... Read More

A Gadfly On A Dinosaurs Butt, Or The Hood-winking Of The American Investor

Have you ever noticed how some words in the English... Read More

Direcway & Wildblue Set to Square Off this Fall?

There is a cat fight brewing between Direcway LLC, Starband... Read More

Poll Names Coin Laundries Best Investment For 2005

According to Morton Pollack, CEO of PWS, The Laundry Company... Read More

It Is Never Too Early To Start A Roth IRA!

The Roth is kind of weird until you get used... Read More

June 2005: Weather Forecasts for Weather Traders

If Johannes Kepler, the renowned 17th century astronomer and discoverer... Read More

Investing Pointers for Neophyte Investors

If you know next to nothing, how do you go... Read More

What Is A Fair Market Value, Really? If Youre Going To Trade, Be Sure Its Worth It!

I've been involved in online trading, specifically with stock and... Read More

Maniac Investment

Let's first understand what maniac means. According to Webster a... Read More

Remembering TEOTWAWKI and Learning from It

Its only been about 5 years since we had major... Read More

Quit and Retire Three Years Earlier!

For most people, there is a direct correlation between how... Read More

Retirement or Financial Freedom?

In the past most people never retired. They died. The... Read More