Uncovered Options Trading

Uncovered options trading can be risky, compared to writing a covered call option. On the other hand uncovered options trading can be very profitable. Because of the high margin requirements uncovered or “naked” options trading is usually considered the province of institutional investors. Statistically it is more profitable to sell uncovered options that to buy the same options, providing that the trader has sufficient reserves (margin) to cover the risk of losing big on the occasional trade.

Engaging in uncovered options trading can be an effective short options trading strategy providing that the options trader is experienced, trades in “known territory” and uses a bit of common sense. Of course it also helps to have the $100,000 or so margin requirement too. People who routinely sell naked calls and puts are usually those making a living trading options. They most typically avoid historically volatile stocks and, in the case of institution investors, have a huge amount of research available to them in choosing which stocks in which to sell naked calls.

Looking at the kinds of options trading it is useful to look at comparisons. In uncovered options trading the trader does not need to invest money in buying stocks although he or she needs to have a substantial amount of money in the margin account. Because the trader does not own stock he or she avoids some of the attendant risk. An example would be someone sells uncovered call options. The trader does not own the stock but has sufficient margin to be able to trade. The trader gains if the stock does not go up in price. He or she gains the premium, has not had to buy stock, and does not suffer a loss if the stock goes down in price. The writer of a covered call option will gain a premium if the stock price stays put or goes down but will lose money in his stock portfolio if the stock loses money. This is part of why uncovered options trading in call options can be more successful than covered call option writing.

For someone new to options trading who only does occasional options trading there is a word of caution. Success in uncovered options trading has largely to do with the right choices in which stocks to trade. The value of options tends to get smaller with time as the chance of a stock changing price sufficiently to cause the option buyer to exercise the option diminishes. This is key to making money in selling naked call options. Picking a quiet stock, quiet market sector, and avoiding this type of trading when the market is very volatile are all good ideas for the beginner in this type of options trading.

Risk management in options trading is important. Big institutional investors have their stocks and market sectors and lots of research. There is no reason that a private investor cannot engage in uncovered options trading. All they need is the $100,000 or so for margin, lots of time, lots of research, and the common sense to stick to the stocks and sectors that they know.