Naked Calls

If you sell a naked call and the stock price moves against it, buy the shares before the strike price is reached, and sell another naked call at a new and higher strike price. You need adequate amounts of a cash position to cover all your naked calls with such stock buys. If you buy the 100 shares before the strike price is reached, you then want it to be reached, as this will make for a small gain on the sale of the stock and will also free you of it.

The big risk here is a gap up in stock price that goes well past the strike price, preventing you from buying the stock at a price below the strike price. Quarterly earnings or a takeover bid or some other unusual event can cause such a gap up. You might consider rolling the losing call out and up to get it closer to the higher price of the stock if you think this rise in the stock price is not going to be sustained. If you do think the stock price will be sustained and may well rise even higher, then take the loss and buy back the losing call — some losses are inevitable and are therefore part of the cost of trading options.

The other risk is if you buy the 100 shares before the strike price is reached, and then the stock price collapses — so you are left with 100s shares going into the red. If the stock price drops precipitously enough, but you consider this a normal and reasonable correction, consider selling a put to collect premium and establish a strangle. The premium on the sale of the put will lower your average cost of the stock.

Paul Morphy’s Games

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