While theoretically the selling of naked options carries with it the potential for unlimited loses, in the real world this so-called risk is controllable to such a large degree as to be meaningless. Thousands of option sellers are successfully making a good living and growing their capital doing nothing but sell naked options. The fact is, all these successful traders are employing certain safeguards or protective trading strategies that allow them to defeat this ‘unlimited risk’ factor.

Those who believe that naked option selling has the potential for ‘unlimited loses’ are obviously misguided in their belief. Selling or writing naked options when done in a disciplined manner coupled with proper protective trading techniques and sound money management is no riskier than buying options. Seasoned options traders who specialize in naked writing regard option buying as a riskier, more speculative trading strategy. Statistics show there are more traders who lose money as option buyers than option sellers.

Options are decaying assets. They lose value each day that the underlying stock to which they are attached remains unchanged or moves in a negative direction. The magnitude of daily losses depends on many factors but the primary one being the behavior of the underlying stock. An option buyer (versus an option seller) is faced with this dilemma and can only be a winner if he correctly determines the movement of the stock and the magnitude of the move. If the market moves in the opposite direction or if it does not move at all, the option buyer is a loser. The option buyer must not only correctly foretell market direction but his prediction must be accompanied by a major move in the market. A less than significant move will still result in a loss for the option buyer.

On the other hand, the option seller takes maximum advantage of the decaying characteristic of options. As an option seller he merely sits and waits for the option to lose value daily to the point of being worthless on expiration day. He does not need to correctly predict market direction to generate profits. If he sells puts, he is a winner if the stock stays flat, a winner if the stock goes up. He can only lose if the underlying drops far enough to hit past his strike price position. This means that even if the stock goes down he is still a winner if the move is not far enough to hit his strike position. If he is a call seller, he wins when the stock drops, stays flat or moves up less than significantly. Admittedly, during the validity period of the option until its expiration date, the option seller faces the potential threat that the underlying stock may move continuously against him past his strike position, in which case there would be no limit to his loses. But this can only happen if the seller is careless enough not to watch and monitor his position on a regular basis!

Options are not ‘buy and hold’ securities. All options traders, buyers and sellers alike, carefully watch their positions on a regular frequency. In their march towards expiration dates options are always in motion in tandem with their underlying stocks thereby continuously presenting opportunities for making profits or presenting danger signals for incurring losses. Option sellers are a more cautious lot than buyers and consequently sellers have developed various protective trading techniques to offset the so called ‘unlimited risk’ factor to the point where it is nearly a neglible risk. What are these trading techniques? Each option seller may have his own system but here are a few strategies that conquer the risk.

1.       First and foremost and probably the most important thing to consider when getting into selling options is the choice of securities. Highly volatile stocks are most susceptible to the highest risks because of their potential for making dramatic price moves up or down. While volatile stocks tend to offer attractive option premiums, this benefit can be cancelled by the higher risk of a major negative move. A price gap out in a stock can cause severe losses. Conservative option sellers who make a living or grow their wealth selling options will often tend to play ETFs (Exchange Traded Funds) or Indexes instead of stocks. These securities seldom undergo dramatic one day moves and it is even less vulnerable to price gap outs.

2.       Careful monitoring of position – As mentioned earlier, option sellers tend to be a cautious lot and anyone who sells options and does not watch the progress of his position can only be considered dumb or stupid. One does not need to be glued to his computer screen and watch every move in the stock market. He only needs a cursory look at the market now and then to see how things are developing. When a situation starts building up where one’s short position may be in danger, action can immediately be initiated before it degenerates into a bad situation. The option sold may be bought back immediately at a slight loss before it gravitates to bigger losses. This slight loss can be no more than what an option buyer would be exposed to in a similar negative scenario. And this is assuming the option seller does nothing more than buy back the losing position. But if his monitoring is combined with the other strategies illustrated below then the risk of loss is nearly nil.

3.        Use of stop losses – For the trader who does not have the time to occasionally watch the market he may use stop losses on his positions at the same time that he initiates the short positions. There is no need to explain here what a stop loss is as it is presumed anybody who is in the stock and options market knows what this is. Additionally, with the advent of online trading, electronic alerts can be initiated with brokers so that when a perilous situation starts developing an automatic alert signal is sent to the trader’s email, iphone, or cell phone.

4.       Use of credit spreads – Here again there is little need to explain what a credit spread is as once more it is assumed that options traders know what this strategy entails. This trading method coupled with careful monitoring and the use of the stop loss is enough to almost guarantee that the option trader will never be exposed to the fear of ‘unlimited loss’.

5.       Use of the roll-out feature of options – This is one strategy that is not being used to maximum advantage by many option sellers. Based on their personal trading experiences and extensive use of this feature those who have been using it swear by it as a powerful defensive strategy in preventing losses in option selling.

Strategy number 5 above is effective enough when used alone and by itself, but when combined with the other strategies above, the whole system becomes a formidable program that almost totally eliminates losses in option selling. One particular options seller has personally developed his own system of using a combination of all the above in his option trading activities and he says with much confidence that he sleeps very well at night thinking he will never ever be subjected to the so called risk of ‘unlimited losses’. He has written an e-book about his system and in it he describes in much detail the methodology he uses in overcoming the risk. Anyone interested may visit his web site at: http://www.theoptionseller.com

For those who are contemplating of getting into the option selling business, pay no heed to the naysayers. Next time you hear someone say “naked option selling is extremely risky due to the potential for unlimited losses” that person is most likely an option buyer who has never ventured into the lucrative field of option selling. His remark obviously comes from his ignorance of the inner workings of options and the various safeguards available to the option seller. To the knowledgeable option seller the risk of losing money is less than the risk facing the option buyer.

For a long time I couldn’t say those words as I struggled just to hold on to my capital, let alone make it grow.

Though there were several reasons why I struggled (including being grossly undercapitalized and at the same time placing too much of my trading bank on individual trades) the main reason for my struggle I believe was a lack of focus.

By ‘lack of focus’ I mean that I was constantly jumping around trying to implement too many different option trading strategies from basic call and put buying, to putting on multi leg spread tades, believing that the more complex the strategy, the greater my chance of success.

I had become a ‘Jack Of All Trades & A Master Of None’ and the only people that were making money from my option trading were my brokers.

One day a friend of mine (a very successful futures trader) said to me, “You don’t need to know everything about trading the markets to make money and be a success. You just need to ‘focus’ and become an expert in one or at most a few different trading strategies and know exactly when and how to use them. The rest is just practice!”

Those words rang loudly in my ears and from that point onwards I narrowed my focus.

I decided that I would go back to the very basics of option trading and only buy calls and puts with the intention of becoming very good at picking the short-term direction of stocks.

Today, almost 2 years later and after going through a steep and often expensive learning curve, buying calls and/or puts is what brings in the largest portion of my current monthly income.

I also use a couple different spread trading strategies when the market moves sideways, but my main ‘focus’ is on picking the short-term direction of a small number of stocks that I have gotten to know VERY well (through backtesting), and then buying the appropriate option based on risk vs reward and my short-term outlook.

The success I’m enjoying today (19 profitable months out of the last 24) is due to becoming proficient at reading stock charts and developing an option trading system that I am comfortable with and performs well and by applying my trading rules consistently.

Ultimately you only need to know a few different strategies to be able to trade any stock up, down, or sideways.

The options themselves are simply the ‘tools’ to make money from your ‘opinions’ and in my experience the tools that are the easiest to use, have also been the most profitable.

Where can I learn how to trade options with consistent profits focused on Implied Volatility without Historical Volatility? Follow the link below, entitled “Consistent Results” to see a model retail option trader’s portfolio that excludes the use of HV and focuses on trading only IV. I’ll cite these actual historical events, to bolster the argument for removing Historical Volatility from your trading process altogether.27 Feb, 2007: Widespread Panic from the sizeable China sell-off in equities. If you were trading the options of an index like the FXI which is the iShares product of China’s 25 largest and most liquid Chinese companies though listed in the US; but they are headquartered in China, you would have been impacted. While you can argue it’s possible to have market events recreate the ranges of the Dow, Nasdaq & S&P, how do you recreate the scenario of the VIX and VXN soaring 59% and 39%?22Jan, 2008: Fed cuts rates by 75 basis points prior to the scheduled policy meeting on Jan 30th, whereby the FOMC cut another 50 basis points on the date of the meeting.  If you were trading interest-rate sensitive sectors using the options on a Financial ETF or a Banking Index like the BKX; or, the Housing Index like the HGX, you would have been impacted. And in the current environment of rates being near zero, the FOMC while they still have a rate policy tool, they are unable to cut rates by the same number of basis points like before. What was a historical event is not successively repeatable going forward, not until rates are raised again and subsequently they get cut again.Question: How do you reconstruct history?  That is the history of events forming Historical Volatility.  The answer is in the real examples cited, as with any other financially related historical event – you cannot reconstruct history. You may be able to mimic parts of HV but you cannot repeat it in its entirety.  So, if you continue using HV-IV crossovers, you visually confuse yourself by searching for volatility “mispricing” patterns that you would like to see; but, you will end up with poor profit performance instead.  It makes more practical trading sense to focus purely on IV; then, diversify the trading of volatilities across multiple asset classes beyond equities.Where can I learn more about trading IV across multiple asset classes using only options, without having to own stock? Follow the link below (video-based course), that uses IV Mean Reversion/Mean Repulsion and IV Forecasting, as reliable methods to trade the implied volatilities across broad-based Equity Indexes, Commodity ETFs, Currency ETFs and Emerging Market ETFs.

Now, let’s compare the above spreads with these other types of spreads.

Clearly, there are more spreads that require the Implied Volatility to be differentiated between Calls versus Puts, compared to the use of a combined IV. So, in choosing a data provider of Implied Volatility, make sure you get the IV data of Calls that is set apart from the IV of Puts; as well as, data that combines the IV of Calls and Puts together. That means 3 sets of IV data in one service.We have just established the structural logic for decoupling the IV of Calls from the IV of Puts. How do you apply this to a trade? Here’s how.

Is there a working example of a consistently profitable portfolio that treats Implied Volatility of Calls separate from the IV of Puts? Yes. Follow the link below, entitled “Consistent Results” to see a model retail option trader’s portfolio that applies this logic.To conclude, I’ll use an analogy. Though an egg comes in one shell, the yolk is separated from the white, for a different purpose that distinguishes the individual parts of that same egg. Treat Implied Volatility of an option’s anatomy in the same way.

Guy Cohen has extensive experience of both the US and UK derivatives and stock markets.  He specializes in trading and analytics applications ranging from real estate to derivatives and has developed comprehensive business, trading and training models, all expressly designed for maximum user-friendliness. There are adequate reader reviews on Amazon and Google Book Search, to help you decide if you will get the book. For those who have just started or are about to read the book, I’ve summarized the core concepts in the larger and essential chapters to help you get through them quicker.The number on the right of the title of the chapter is the number of pages contained within that chapter. It is not the page number.  The percentages represent how much each chapter makes up of the 302 pages in total, excluding appendices.1  The Four Basic Options Strategies.  20, 6.62%.2  Income strategies.  68, 22.52%.3  Vertical Spreads.  30, 9.93%.4  Volatility Strategies.  56, 18.54%.5  Sideways Strategies.  44, 14.57%.6  Leveraged Strategies.  20, 6.62%.7  Synthetic Strategies.  54, 17.88%.8  Taxation for Stock and Options Traders.  10, 3.31%.Focus on chapters 2, 4, 5 and 7, which makes up about 74% of the book. These chapters are relevant for practical trading purposes.  Here are the key points for these focus chapters, which I’m summarizing from a retail option trader’s perspective. Chapter 2: Income Strategies. These strategies construct spreads where part of the spread sells Theta as premium within a shorter term (typically 30-45 days), to collect income.  In its entirety the strategy may result in a Net Debit or Net Credit spread.  There are 13 types of spreads in this category: Covered Call, Short (Naked) Put, Bull Put Spread, Bear Call Spread, Long Iron Butterfly, Long Iron Condor, Covered Short Straddle, Covered Short Strangle, Calendar Call, Diagonal Call, Calendar Put, Diagonal Put and a Covered Put (a.k.a. Married Put).Chapter 4: Volatility Strategies. These strategies use spreads that are indifferent to price direction, so long as price explodes out of range.  For a given explosion in price, the volatility of the spread needs to rise for a Net Debit spread and fall for a Net Credit spread,.  There are 11 spread types are defined in this category: Straddle, Strangle, Strip, Strap, Guts, Short Call Butterfly, Short Put Butterfly, Short Call Condor, Short Put Condor, Short Iron Butterfly and Short Iron Condor.Chapter 5: Sideways Strategies. These strategies involve non-directional spreads, requiring price to drift within a confined range. As price remains range bound, the volatility of the spread needs to rise for a Net Debit spread and fall for a Net Credit spread.  There are 11 types of spreads in this category: Short Straddle, Short Strangle, Short Guts, Long Call Butterfly, Long Put Butterfly, Long Call Condor, Long Put Condor, Modified Call Butterfly, Modified Put Butterfly, Long Iron Butterfly and Long Iron Condor. Chapter 7: Synthetic Strategies. Synthetic strategies mimic the risk profile of a stock, futures or other option position by combining calls, puts with or without stock.  Though typically, most synthetic positions are either long or short stock.  If you have a 401K plan or employee stock purchase plan that is long stock, then it may make sense to consider synthetic strategies, as you are already long Delta.  There is unlimited risk for some synthetic spreads, regardless if the strategy involves stock or not.  There are disadvantages to using synthetics.  12 spread types are defined in this category: Collar, Synthetic Call, Synthetic Put, Long Call Synthetic Straddle, Long Put Synthetic Straddle, Short Call Synthetic Straddle, Short Put Synthetic Straddle, Long Synthetic Future, Short Synthetic Future, Long Combo, Short Combo and Long Box.From a retail option trader’s viewpoint, I prefer to establish positions without the use of stock.  Using stock synthetically in a position makes each trade more capital intensive than it needs to be.  Especially, if your trading account is below USD $50,000.  The use of stock in configuring these positions does not add material merit in controlling risk and there is no added monetary benefit in tying up available trading capital in a stock-dependent synthetic position that could otherwise be achieved without the use of stock.  As an options trader in the first place, you want as little to do with the stock itself as possible, other than to configure the required option position around the underlying product, which can be substituted with a cash-settled Index instead of a stock-settled Index.Out of a total of 56 strategies covered in the book, I have reduced the list down to 35 Limited Risk Spread types that do not need to include stock as part of its original construction.  Limited Risk means there is a cap to the maximum loss – “Capped Risk” is the term used in the book. This should always be the starting point of any strategy you choose to construct. Do not just look at the unlimited profit (Uncapped Reward) side of the strategy without realizing that there is an unlimited loss (Uncapped Risk) side to same strategy.Limited Risk Spreads with “Unlimited” Reward and their Directional outlook.1. Long Call.    Bullish.2. Long Put.    Bearish.    3. Put Ratio Backspread.    Bearish; reverse Bullish.4. Call Ratio Backspread.    Bullish; reverse Bearish.        5. Straddle.    Indifferent/~Neutral.6. Strangle.    Indifferent/~Neutral.7. Strip.    Bearish.8. Strap.    Bullish.    9. Guts.    Indifferent/~Neutral.    1-9 are Debit spreads: IV needs to rise.10. Bull Put Ladder.    Bearish.    10-11 are Credit spreads: IV needs to fall.11. Bear Call Ladder.    Bullish.    Limited Risk Spreads with Limited Reward and their Directional outlook.12. Bear Put Spread.    Bearish.13. Bull Call Spread.    Bullish.14. Long Call Calendar.    Bullish; Indifferent/~Neutral.15. Long Put Calendar.    Bullish; Indifferent/~Neutral.16. Long Call Butterfly.    Indifferent/~Neutral.17. Long Put Butterfly.    Indifferent/~Neutral.18. Long Box.    Indifferent/~Neutral.19. Long Call Condor.    Indifferent/~Neutral.20. Long Put Condor.    Indifferent/~Neutral.21. Long Iron Butterfly.    Indifferent/~Neutral.22. Long Iron Condor.    Indifferent/~Neutral.    12-22 are Debit spreads: IV needs to rise.23. Bear Call Spread.    Bearish.    23-35 are Credit spreads: IV needs to fall.24. Bull Put Spread.    Bullish.25. Short Iron Butterfly.    Indifferent/~Neutral.26. Short Iron Condor.    Indifferent/~Neutral.27. Diagonal Call.    Bearish.28. Diagonal Put.    Bullish.29. Modified Call Butterfly.    Bearish to ~Neutral.30. Modified Put Butterfly.    Bullish to ~Neutral.31. Short (Naked) Put.    Bullish.32. Short Call Butterfly.    Indifferent/~Neutral.33. Short Call Condor.    Indifferent/~Neutral.34. Short Put Butterfly.    Indifferent/~Neutral.35. Short Put Condor.    Indifferent/~Neutral.Other than the 35 Defined Risk Spreads that do not require stock as part of their original construction for entry, there are 6 Defined Risk spreads that need stock to configure their positions. The 6 positions that I have deliberately excluded from the list above are the Long Call Synthetic Straddle, Long Put Synthetic Straddle, Synthetic Call, Synthetic Put, Collar and Covered Call.In conclusion, for new to intermediate traders do not be overwhelmed by the 56 strategies in the book.  It’s entitled the “Bible of Options Strategies” for a reason. What is critical is to get a deep understanding of the Long Call, Long Put, Short Call, Short Put, Long Vertical Call/Put, Short Vertical Call/Put and the Long Calendar Call/Put. That is the 4 Basic Options Strategies, plus the Vertical and the Calendar – the only 2 strategies that floor traders define as true spreads. The other combinations are a mixture of the basics with or without stock.