When we trade options our aim in both the short and long term is to make a profit. Our tools are calls and puts which we can either buy or sell. Over the long term is it more profitable to buy or sell options? If all an average trader ever does is buy calls or puts, he or she will lose more often than win. If all that average trader does is sell calls or puts, he or she will win more often than lose. So, which is the better approach if all you are doing is trading naked calls or puts? The answer lies in the depth of your pockets versus the size of your trades.
Win to Loss Ratio for Calls and Puts
Across the entire options market, traders who trade naked calls make money one time out of four. They always pay a premium for their trade. The profit potential of any given call is virtually unlimited but as a practical matter huge wins are exceedingly rare. Thus, the one-in-four win rate results in this being a losing strategy over time. The advantage of selling (writing) calls and puts is that they collect a premium with every trade. Three times out of four, on average, he or she keeps all or part of the premium and typically losses are not excessive. The one huge downside to just selling puts and calls is that there is a very small risk of huge losses. Thus, the only traders who survive over the long run are those with very deep pockets so that they can survive the occasional catastrophic loss.
Hedging Risk in Options Trading
Fortunately, option traders are not limited to buying or selling naked calls or puts. A trade that we commonly use at Top Gun Options is the bear call spread. We use this approach when we expect to see an index like the S&P 500 or a specific stock fall in price. This strategy consists of selling a call for which we receive a premium. This, by itself, would be a naked call. It would generate more profit than loss over time but would be at risk for an occasional big loss. The other part of the strategy is to buy a call at a slightly higher strike price. Each call is for the same amount with the same expiration date. The purchase of a lower-priced call reduces our initial credit with this trade but removes the risk of a potentially huge loss. Over time this approach generates excellent income, providing that you are accurately assessing the market’s likelihood of falling. If your assessment of the market is faulty this approach keeps your from going broke in a single trade!
Which Option Strategy to Choose
Today’s stock market is a risky place to be trading with Putin’s war in Ukraine, the potential for China invading Taiwan, the Fed raising rates and risking a recession, China’s covid lockdowns gumming up the supply chain, and more. This is not the time to be selling naked calls or puts due to the risk of huge market swings. And it is not the time to waste money on naked calls when you are uncertain where the market is headed. This is a good time to join one of the trading squadrons at Top Gun Options where we potentially print money no matter which way the market is headed and always hedge our trades to limit risk and optimize our profits.