In an uncovered call or put, a naked option position, if the price of the stock goes opposite to your expectat

Question

ions, through your strike price to the opposite end of the spectrum, ie (call if it goes down, put if it goes up), what could happen to your finances and or earnings and what actions would you take to prevent excess losses? I take it that naked options are important to pay attention to?

In the case of a writer I get it that there is liability, but in the case of a buyer, it is just the premium you lose, right?

Answer 1

You could lose as much as the stock can move. And yes, they are very important to pay attention to. That's why most brokerage firms won't allow you to trade naked options initially.

Several things you can do to prevent taking excess losses.

1) have an offsetting position such as stock or another put/call option. (ie. sell a SHLD 190 call, buy SHLD 200 call)

2) Have a stop loss order in place immediately when your naked option is sold

3) Have other positions in your portfolio that would increase as the option losing money loses more money.

Hope that helps!

Answer 2

One very popular strategy is to buy an offsetting call, put at a higher, lower strike price. That limits your potential liability.

Answer 3

Go on the internet and look for options payoff diagrams!