Never Sell Naked Calls

I never sell naked calls, because there is just too much risk involved. How much risk? Infinite! That is right there is no limit to how much you risk on a naked call.

When you sell a naked call you are giving someone else the right to buy a given stock at a given price on or before a given date in the future. So say you sell the $40 call on stock XYZ and make $2. That is a pretty easy profit.

The only problem is now you are obligated to sell XYZ at $40. If the stock goes up to $100 then you will have to go buy it at $100 and sell it at $40. That gives us the opportunity to take a huge loss.

So does this mean that selling a call is always bad? No, but it does mean that naked calls are probably not a very good idea. But you can combine this strategy with a stock to make a covered call trade.

When you place a covered calls trade you actually own the stock. This way you do not have to go out and buy it if the stock jumps. Let’s say instead of just selling the $40 call on XYZ for $2 we also bought the stock XYZ for $38.

Now if the stock jumps to $100 we could always just sell the stock we already own instead of having to go out and buy it. That severely limits our loss, in fact the only way we could lose on this trade is if the stock goes down below $36, (Because we spend $38 but made $2) which also gives us a higher probability of being right.

For more on covered calls and puts visit http://www.stocks-simplified.com/selling_puts.html

For more stock tips visit http://www.stocks-simplified.com/stock_tips.html