Hence, the "naked" part—meaning you're exposed, without a safety net. Investors often sell puts in combination with other options contracts such as for put spreads to limit downside risk. The decline in time value works against the buyer, but it is a valuable benefit to the seller. An unexpected announcement of bad news might cause the underlying stock to gap down in price, which could result in such a loss. I believe it is always a good idea to limit losses.
Naked Short Dos and Don'ts: Pointers for Shorting Opt Ticker Tape
For example, refer to Figure 1 below:. The beauty of having your broker only require a small percentage of the stock price is it increases the potential return on investment. Second, the gray line drops considerably less in and thus recovered back to even much quicker. If assigned, the goal would be to resell the stock as quickly as possible to minimize the duration and risk of stock ownership. As an options trader, you will have the ability to get paid for promises you rarely have to fulfill. Expiration Risk This risk applies, too.
Setting a bailout point is a way of insuring that you will use this right when the price hits the parameters you have set. When you go naked with a put, you are hoping that the stock price will rise. The following series of questions comes from a rookie options trader. Another benefit of short selling is that it frees up some cash. Having said that, it should be relatively simple to drive the stock price though your options strike near expiration and pocket the profits in the options positions as well as the stock price depreciation. And the magnitude of losses for the average trader tends to dwarf the magnitude of the winners—such that the expected gain of a net-shorting strategy ultimately equals the expected gain from a net-buying strategy.