Risks of Options Trading

Listen carefully: The Risks of Options Trading are real. Now, I don’t want to scare you off. Quite the contrary. When done with safety in mind, with a well thought-out plan, and contingencies in place, safe options selling can be a sustainable and profitable way to make extra income. That’s the purpose of this website, to educate you about safe options trading techniques.

Nevertheless, I would be remiss to not cover the risks of options trading with honesty and clarity. So, let’s be aware of some of the risks associated with options and options selling in particular. These include the risks of leverage, the risks of volatility, the risks of trading naked, and the risks of assignment. I’ll discuss some of these. The graphic below is meant to visually suggest that you not discount these risks.

Volatility: Keep in mind that options can be highly volatile in price. While this can make for exception profit potential, it can, especially when couple with leverage, magnify loss potential as well. Safe Option Seller Take Away: Again, use cash-secured put selling and covered calls as your principal options selling techniques. Do not trade naked as you begin this business.

Trading Naked: What’s that you say? What do you mean trading naked? This does not mean putting on a trade with no clothes on. Instead, it refers to selling options on margin without having all your potential obligations secured by holding sufficient shares of the underlying stock (as in the case of covered calls) or enough cash held in collateral (as in the case of a cash-secured put). Trading naked is highly risky; in the case of naked calls it exposes you to theoretical unlimited loss. It is sufficiently risky that beginners will not be permitted by their brokers to sell options naked; you will need plenty of experience and then ask your broker to grant you this privilege. Safe Option Seller Take Away: Don’t even think of trading naked until and unless you become adept at covered calls and cash-secured puts and have paper-traded naked option sells for a sufficient period of time that you are comfortable. Then think again, especially in the case of naked calls.

Assignment: Are you really prepared to be put the shares (if you sell cash-secured puts) or part with your shares (if you sell covered calls)? You must be prepared to meet to obligations of the option seller, should they arise. Also, be aware that early assignment (prior to expiration day) can and does occur, although it is not particularly common. Safe Option Seller Take Away: Make sure you have a well-thought out plan. By using safe methods you’ll be in financial position to meet an assignment, but are you mentally prepared? Decide ahead of time if you would or would not mind being called out or being put to. And design your plan with these contingencies in mind.