What you are really doing when you roll out your short, naked options

W

So,  you just watched free training from your options broker and you’re so excited that you just found the Golden Goose.  Wow, high-probability wins!  What could be better?

You like the way your broker/trainer keeps saying “three standard deviation move”.  It just sounds so smart and he seems so confident about it all.

Ugh.

So…

You just risked too much money in another unlimited risk position and the underlying just blew past your short, unhedged options.

You are down.  Big.

“No problem”, the broker/educator says. “When that happens you just roll out naked option position and collect even more premium!”

Wow! Really? No.

No. You didn’t collect even more premium free and clear — it is offset by your liability (the new short option position). Yes, you collected premium and you also paid up to close out your previous loss at the same time. So, have a new liability. Your loss did not go anywhere. You are just keeping the trade open.

In rolling out your loss into a new longer-dated DITM (or ITM) option, you have kept all the same risk on, and in return you have collected a diminished premium (remember, you are no longer near-the-money and extrinsic value is lower and lower as you go in or out of the money).

I am very familiar with this argument and the dogmatic (manipulative) teachings about this.  So, I propose a question to these acolytes:

“Would you normally sell a DITM option to express an directional opinion?”

–“No,because I don’t make directional trades and I never trade DITM options because they are just the equivalent of stock”

“So, you have a directional opinion, then?”

— “No, only suckers play options for direction… smart traders only sell options to collect time premium, which is always eroding”

“Then you must like the time premium (extrinsic value) you’re collecting from this short DITM option in exchange for continuing to take unlimited risk?

— “No, not at this strike. But I collect a ton if intrinsic value that goes straight into my account”

“Right, but that is offest by the position so you are still at a loss from your previous trade. So you are just putting on this position in blind hope that the trade comes back in your direction and makes you whole again?”

–“No, I collected premium for this so I am a premium seller”

“Wow.”

Another way to tell this story is that you had a losing trade and, rather than cutting the trade and looking for another opportunity, you kept risking more and more just prove you were really right all along. Maybe you actually hope to prove to yourself that you have found a way to never have a losing trade again!

I’m not sure what is so enticing about this kind of education for so many, but this advice is very dangerous.  The trader will likely be cut off before he loses too much more than his full account value on a massive losing trade, but odds are he will have spent a good portion of his account on commissions for all those “small” trades he likes to make so often, with no clue what he is really risking.

There is a time and a way to sell options premium.  To me, this is neither.

(And I never sell naked options)

To good trades,
Todd

About the author

Todd Gill
Todd Gill

Todd Gill is a private trader, trading his own account and the accounts of select family members. Depending on the current market environment and context he will trade stock options, futures options and futures spreads. With all trades and at all times, his goal is always twofold: to manage risk while leaving open the potential for massive winning trades. For more information, see wwww.thetradersjourney.com

Todd Gill By Todd Gill

Posts