What are the characteristics of this option strategy?
Naked call selling means writing an out-of-the-money call option on a security you do not own, and keeping the premium if the stock stays below the strike. It is an advanced income strategy that pays from the time decay of the option premium, and it works best when the underlying falls or trades sideways. Because no stock sits behind the short call, a rally through the strike produces a loss that has no upper bound.
Is this a bullish, bearish, or neutral strategy?
The Naked Call Option Strategy is a bearish strategy. The trader is taking a directional view of the security as he/she is selling options and looking to benefit from either the time decay of the option premiums or underlying security going down.
Is this a beginner or an advanced option strategy?
The Naked Call Option Strategy is a comparatively advanced option strategy. This strategy requires a trader to have a deep understanding of implied volatility and the impact of the delta on option prices.
In what situation will I use this strategy?
This strategy can be used in situations where the trader is expecting the underlying asset to remain range-bound or only move downward over time. The trader may also use this strategy in situations where the underlying security has high volatility and therefore, is likely to have high option premiums.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The risk-reward for the Naked Call Option strategy is sharply asymmetric against the seller. Since the trader does not own the underlying security, the maximum reward is capped at the option premium received, while the loss above the strike is unlimited and grows dollar for dollar with the stock. The probability of profit can be high, because most out-of-the-money calls expire worthless, but it is the size of the rare loss, not the frequency of the small win, that has to be sized for.
How is this strategy affected by the greeks?
The greeks (delta, gamma, vega, theta, rho, etc.) have a significant impact on the performance of the Naked Call options strategy. The vega of a short Naked Call falls toward zero as expiration approaches, and the delta of an out-of-the-money call also decays toward zero unless the stock moves through the strike, in which case the delta accelerates toward 1 against the seller.
In what volatility regime (i.e VIX level) would this strategy be optimal?
Elevated implied volatility at entry raises the premium received, so the maximum gain is largest when option prices are rich. What the seller needs after that is for realised volatility to come in below the level that was priced in, because a quiet tape lets the call decay while the stock stays under the strike. A rising VIX once the position is open works against it: the short call is marked higher and the market is pricing a larger chance of a move through the strike.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
It is important for traders to have a solid exit strategy for this strategy in place before entering into the position. If the trade goes against the trader, he/she should look to exit the position immediately to limit the losses. The other common repair is to buy a further out-of-the-money call, which converts the naked call into a vertical spread and puts a ceiling on the loss for the first time. Adjusting this strategy can be somewhat difficult as it requires an understanding of the impact of the greeks on the position, and rolling the short call higher or further out only postpones the exposure, it does not remove it.
Where does this strategy typically fall in the range of commissions and fees?
The commissions and fees associated with the Naked Call Option strategy typically depends on the broker. Generally speaking, this strategy will result in higher commissions and fees compared to strategies that involve buying options.
Is this a good option income strategy?
The Naked Call Option strategy can generate steady income from the time decay of the option premiums, but it is not a conservative income strategy. Each small premium is collected against an open-ended loss, and a single gap higher through the strike can erase many months of collected premium. That is why brokers require margin and a high approval level for it.
How do I know when to exit this strategy?
The trader should have a predetermined exit strategy in place before entering into the position. Generally speaking, it is recommended to exit the position when the option premium has been reduced to an extent that it is no longer worth holding it.
How will market makers respond to this trade being opened?
When a trader opens a Naked Call Option position, the market maker may respond in one of three ways. Firstly, the market maker may bid up the price of the option thereby reducing the potential gains from the trade. Secondly, the market maker may stay away from the trade and not submit any bid or offer. Thirdly, the market maker may even offer a spread which may result in the trader realizing higher profits.
What is an example (with calculations) of this strategy?
Suppose a trader believes that the price of security A will remain range-bound or will go down and he/she expects to benefit from the time decay of the option. The trader can then sell a Naked Call on security MSFT with a strike price of $290. At the time of entering into the position, the trader collects an option premium of $178, or $1.78 per share on the one contract. The breakeven at expiry is $291.78, the $290 strike plus the $1.78 premium. If MSFT closes at or below $290 at expiry, the call expires worthless and the trader keeps the full $178, which is the maximum gain on the trade. Between $290 and $291.78 the premium is partly given back, and above $291.78 the position is at a loss. There is no maximum loss to calculate: the stock can rise without limit, so the loss on a naked call is unlimited, growing dollar for dollar with the stock above the strike. MSFT at $340, for instance, costs $5,000 of intrinsic value against the $178 collected, a net loss of $4,822 on one contract.
Using MarketXLS to Help With Option Trading Strategies
Trading options can be complicated and it is important for traders to have a deep understanding of the option strategies before entering into a position. MarketXLS provides a range of Excel tools and templates that can help traders track and manage their options income. For example, traders can use the Tracking and Managing Options Income Excel Template to track their income from options trading. Similarly, traders can use the Iron Condor Excel Template to execute and manage Iron Condor trades. MarketXLS provides an array of Excel tools and templates that can be used to track and manage options trading.
Here are some templates that you can use to create your own models
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic
Long Diagonal Spread With Puts Option Strategy(Excel Template)
Diagonal Spread With Calls Option Strategy (Excel Template)
Iron Condor (Excel Template)
Craft Your Own Strategy with Active Options Trading
Short Call Put- Managing And Tracking