If I sell a naked call for a premium, can I buy the stock to cover the "nakedness" should the share price rise

Question

Ok, so lets say the stock is trading at 50, and the next month 60 strike calls are selling for $1.25....if I sell/write those calls and the stock price starts to rice up towards 60 (and the premium for those calls increase) I could be liable for any amount the stock rises over $60.00, but could I just buy the stock prior to it getting to $60.00 to make it a covered call, and essentially removing any liability that could be created from upward movement? Is this a good strategy?........................ Thanks...

Well, lets say the stock rises to 59.00 a share, with a week til expiration, and lets say the 60 call premium is now $2.50. Wouldn't it make sense to buy the stock at 59.00, at which point the call I sold will be covered by the stock, so if it goes to 65.00 and the calls are exercised, I can just sell my shares that I bought for $59.00, for $60.00.....hence I get to keep the premium I received from selling the call, and the only money lost would be if the stock sinks below the price I bought it for minuse the premium received.....am I thinking about this transaction correctly, is this trade allowed? Am I missing something, it seems like a no brainer....I guess the risk is if it is a volatile stock, and I don't have the opportunity to purchase prior to the stock rising above $60.00....

TD Ameritrade lets me write options, they have given me level 4 status.....I just finished "Options Made Easy" by Guy Cohen and I am ready to become an expert---hahahaha.

I plan on implementing the strategy outlined in my question, I will let you know how it goes....I have already executed a couple covered calls on some of my current positions, I executed a spread trade on Google February Puts, which depending on next week will prove profitable, and I have written/sold some calls on LM, they expire Friday.

As the saying goes, greater risk==greater reward, I only wish I dove into the options market sooner....don't worry I will start conservative and stick with spreads and covered calls, and WAY out of the money writing/selling...etc. Thanks for your input...

All, thanks for the answers and your time, all useful answers, exactly what I was looking for...thanks for the links. How ever the best answer I am selecting I think answered the question at hand. Though Thanks For All Input.

Answer 1

Unless trading is halted you can buy the underlying stock to convert a naked call to a covered call. However, there is no guarantee that you can buy it at a particular price. If you decide you are going to buy it if it reaches $59, it is possible it will close one day at $57 and gap up to open the next day at $65.

Even if you do buy it at $59, that does very little to reduce your risk. A covered call is a synthetic naked put. After buying the stock you will lose money if the stock goes down instead of losing money if the stock goes up.

By the way, there are message boards at

http://messages.yahoo.com/Business_%26_Finance/Investments/forumview?bn=4686677%23optionsquestionsansweredhere

and

http://messages.yahoo.com/Business_%26_Finance/Investments/forumview?bn=4686677

that a number of experienced traders traders visit regularly

I suggest you use them for any future options question you have.

Good Luck,
Z

Answer 2

In the first place, it's unlikely your broker will allow a naked call write. For the broker - and it's the broker who must make good on the trade in the event of an assignment - a naked call has limitless risk, because the stock price can rise without limit. This is the riskiest option strategy of them all. So brokerage houses control very carefully which clients may sell uncovered calls.

Those who may are level 4 traders who have demonstrated years of successful trading plus the financial capability to manage high risk.

You're to be congratulated because you're thinking about the consequences of an option trade, but the unfortunate fact is that, in this example, you've got things backwards.

Here's how it's done by a level 1 trader, who is learning by practising. First, he buys the stock.

Then, he sells the call option. This is a covered call write, also known as a buy-write. It's the most basic strategy of all, it's very conservative, and every broker will allow it.

Level 2 traders can replace the long stock with a long option, in a calendar or vertical or diagonal spread.

Here are some websites where you could study more:

http://www.888options.com
the options clearing corporation; good tutorials & training materials

http://www.cboe.com
the granddaddy of all options exchanges - chicago; educational resources plus a virtual options tool for play trading

http://m-x.ca
the montreal exchange, and it also runs the boston exchange on its platform; offers an excellent manual on options trading, everything from beginner material to advanced strategies expressed in algebra - click "publications - guides - options reference manual."

Generally speaking, the purpose of selling calls is to generate a stream of capital gains. The time value component of the option premium will decay, particularly rapidly as the option approaches expiration, and so the trader gets to sell calls repeatedly, sometimes over periods of many years. However, he maintains a hedge in the form of either the stock itself or else another option.

Good luck to you.

Answer 3

If the stock rise past $60 you have unlimited liability. Let's say the stock ends at $70, you will have to buy the stock at $70 and sell to the holder of your call option at $60, a $10 loss. If the stock price rise to $100, well, you do the math.

As to whether you should buy the stock to cover. I think you should just buy the call back out right and cut your losses.

Answer 4

I would never advise anyone, especially an options beginer to sell naked calls. Naked puts are ok as they have defined risk, naked calls don't. Why not just do a credit spread instead of a naked call? That way you have defined risk.

Your stock could gap above $60 for some reason and then keep running. You will get exercised before you can do anything then you are sunk. Why risk thousands of dollars to take in $125? Limit your risks and do spreads, not naked options.