Yahoo! Finance
10-09-2006, 03:50 PM
Yahoo Finance Investing Strategies
Getting naked isn't such a great idea when you're selling options
Updated 10/9/2006 3:17 AM ET
ASK MATT ABOUT STOCKS
Investment primer
Q: Why is selling a "naked" call option considered to be so risky?
A: When investors get confident — some might say overconfident — they start looking into options.
Options are financial instruments that give their buyers the right, not the obligation, to buy and sell stocks at a certain price at a predetermined time in the future. They're a powerful tool professionals use to either lock in gains from stocks they own or to take gigantic bets on their hunches.
But as with many tools, financial and otherwise, you can hurt yourself badly if you mishandle options. In a past column, I equate options to dynamite. Used correctly, they can be constructive. But in the wrong hands, they can blow a portfolio to smithereens.
Selling a "naked" call is perhaps the best example of a high-risk proposition that can do a lot of damage real fast. A person who sells a call is giving the buyer of that call a powerful right: To force you to sell the stock to them at a set price. The term "naked" means you're selling the option without actually owning the stock.
An example might clear this up. Let's say you sell a call that gives the buyer of the call the right to buy 1,000 shares of General Electric (GE) from you at $35 a share in December. And let's say the stock was trading at $34.84 at the time. The buyer might pay you, say, 90 cents a share for that option or $900. You pocket the $900. Pretty sweet, right?
Not so fast. If the shares rise to $35.90 by December, you're not so happy. Why? Because the buyer of the call will force you to sell the shares for $35. That means you'll pay $35.90 for the each share and only get $35, wiping out the 90-cents-a-share profit you thought you made.
complete article here... (http://us.rd.yahoo.com/finance/news/rss/story/*http://us.rd.yahoo.com/finance/editorial/usatoday/SIG=12j42fkg4/*http://www.usatoday.com/money/perfi/columnist/krantz/2006-10-09-naked-calls_x.htm?csp=N008)
Getting naked isn't such a great idea when you're selling options
Updated 10/9/2006 3:17 AM ET
ASK MATT ABOUT STOCKS
Investment primer
Q: Why is selling a "naked" call option considered to be so risky?
A: When investors get confident — some might say overconfident — they start looking into options.
Options are financial instruments that give their buyers the right, not the obligation, to buy and sell stocks at a certain price at a predetermined time in the future. They're a powerful tool professionals use to either lock in gains from stocks they own or to take gigantic bets on their hunches.
But as with many tools, financial and otherwise, you can hurt yourself badly if you mishandle options. In a past column, I equate options to dynamite. Used correctly, they can be constructive. But in the wrong hands, they can blow a portfolio to smithereens.
Selling a "naked" call is perhaps the best example of a high-risk proposition that can do a lot of damage real fast. A person who sells a call is giving the buyer of that call a powerful right: To force you to sell the stock to them at a set price. The term "naked" means you're selling the option without actually owning the stock.
An example might clear this up. Let's say you sell a call that gives the buyer of the call the right to buy 1,000 shares of General Electric (GE) from you at $35 a share in December. And let's say the stock was trading at $34.84 at the time. The buyer might pay you, say, 90 cents a share for that option or $900. You pocket the $900. Pretty sweet, right?
Not so fast. If the shares rise to $35.90 by December, you're not so happy. Why? Because the buyer of the call will force you to sell the shares for $35. That means you'll pay $35.90 for the each share and only get $35, wiping out the 90-cents-a-share profit you thought you made.
complete article here... (http://us.rd.yahoo.com/finance/news/rss/story/*http://us.rd.yahoo.com/finance/editorial/usatoday/SIG=12j42fkg4/*http://www.usatoday.com/money/perfi/columnist/krantz/2006-10-09-naked-calls_x.htm?csp=N008)