Uncovered Options Trading System
| Selling Options (Short Positions) | Buying Options (Long Positions) |
| Profitable - Written puts (i.e., puts sold short) can provide a trader with extra income in a flat to rising market. | Profitable - Long puts are profitable only in a falling market. |
| Profitable - Written calls (i.e., calls sold short) can provide a trader with extra income in a flat to falling market. | Profitable - Long calls are profitable only in a rising market. |
| Time erosion is an option seller's ally. Even if the underlying security moves somewhat against the direction of the short position, the sale of short options can still bring in a profit due to an option's time value erosion. | Time erosion works against the option buyer. As a general rule, the longer an option buyer stays in a position, the greater the risk that the purchased option will drop in value - even if the underlying security moves slightly in favor of the long position. |
| Maximum gain - You keep 100% of the premiums received from selling short options. | For calls, the maximum gain is theoretically unlimited. For puts, it is substantial. |
| The maximum loss is theoretically unlimited; however, traders are always restrained to a certain extent by their brokers and by margin requirements. | The maximum potential loss for long options is 100% of the premiums paid for those options. |
| Uncovered options are bounded by high margin requirements, which depends on the selected strike price and current underlying stock price. | Most brokers require to have minimum $2000 (margin) on the account in order to be able to buy options. |
By comparing the benefits (outlined in the table above) of
selling short options and of buying long options, it becomes evident that option sellers have more opportunities to profit. Option sellers only lose money if the underlying security moves substantially against their position (i.e., contrary to the predicted direction). In flat markets - or when the underlying moves modestly against one's position - it is still possible to make money (because of an option's time erosion which benefits the option seller).
On the other hand, option buyers have the advantage when it comes to limiting their potential losses. When selling options short, traders risk losses that can far exceed the amounts originally required to establish the position. In contrast, an option buyer's risk is limited to the amount of the premiums paid.
In summary: Naked options sellers have more opportunities to profit, but they face the risk of larger potential losses. In some situations, losses may be mitigated by the use of a stop-loss strategy. Index options are safer than individual equity options in this respect there are no mergers or buyouts where a stop loss may be meaningless if trading is halted before an announcement is made.
Naked options trading is very risky - many people lose money trading them. It is recommended contacting your broker or investment professional to find out about trading risk and margin requirements before getting involved into trading uncovered options.