You wouldn't Run around Naked. Your Options Shouldn't Either!

Disclaimer: I am not a financial professional nor formally trained in any way. The information in this post is designed to inspire, not direct you. I highly recommend working with a financial advisor, like my amazing one, Josh Collier, when dealing with your family's investments.

Image Credit: Gemini and me ;)

 Last week I wrote a post sharing about what I had learned about covered call options. It was written from a place of naivete and may have caused some of you concern because of that. Sorry. Since then, I've learned more, A LOT MORE. Yes, I read through the 96-page Risks and Assessments document and several other blogs and websites and my eyes were opened. I found out that the covered calls that I had been learning about were just a tiny corner of this vast arena known as options trading, a corner that I'm pretty happy staying in.

 I'm a learner, a researcher, and as I read up on covered calls, I found out that most of the ways people trade with options (calls and puts) involve something called margin. This is essentially trading stock on credit, buying with money you don't have. Just as I've emphasized over and over the importance of paying off your credit cards every month and never carrying a balance, I will emphasize here NEVER TRADE ON MARGIN!!! That would be like plugging your VISA into a slot machine - the house always wins. In the trading world, these are called "Naked Options" because they aren't covered by anything. When my financial advisor sent me off into the world with a few hundred shares of stock to run covered calls on, he told me to never sell uncovered calls. I wonder if he had called them naked calls, would I have listened more? In any case, that's what they are. Little options running around in the world naked. And just like I wouldn't run around in the world naked, my options shouldn't either. 

 Why not? Well, let me paint a picture for you. You sell a call option on margin. You don't actually have the stock in question, but you hope that your option will not be assigned and you can just get away with the premium. It works out pretty good for you, and you make a couple thousand dollars in premium your first few months. But then, the day comes when the stock market surges and your call gets assigned. You are now required to sell the buyer 100 shares of that stock at let's say $50 a share, but today it is trading at $75 a share. So, you go buy $75 worth of stock to sell to the buyer for $50 and take a $2,500 loss. Really, that would be a small price to pay considering some of the stories I've heard. A friend of my husband's related to him when he heard that I was trading options that in his first year he made about $180,000. But then, the next year, trading on margin to increase his gains, he lost $80,000. That's the kind of trouble that trading naked options can get you into. You can lose your house, your car, and everything that tends to follow that sort of catastrophic financial situation. So why do I think what I'm doing is different?

Image credit: Gemini and me

 In the options world there are two types: calls and puts. When you sell a call, you say that you are willing to sell stock to someone at a certain price. When you sell a put, you say that you are willing to buy their stock at a price. When you actually own the stock that you sell a call for, it is called a covered call. When this relates to puts, you would need to have the money promised set aside with your broker and then it is called a cash secured put. And THAT'S what I'm all about. When I'm out there in the financial world, I want my butt covered, literally and metaphorically. So, I will only sell calls for stock that I own, and only in the amount that I own, and I will only sell puts that are cash secured with the money set aside in my trading account. 

 Does that mean I might miss out on some big opportunity? Yes, yes it does. It also means I'm not setting my family up for financial devastation. The *worst* thing that can happen is that I sell the stocks at a lower price than I had ideally wanted, but then at least I have the cash from the sale that I can reinvest as I desire. On the other side, the worst scenario is that I buy stock from an assigned put and then the stock price continues to fall, and I end up with less value. Hopefully, with the puts, the stock will come back up eventually, but that is not guaranteed, so I only invest with money that we don't need for other things like monthly expenses or retirement. Realistically, you face these risks when you do anything with the stock market. That's the price we pay for the potential gains we'd like.

Here's the Thing: I just wanted to come out here today and share with you some of the realities I've learned over the last month or so and hopefully add to your understanding of the options market as well as ease some of the concerns you might have had about what I'm up too 😉