Page 310

shape, covering the puts (the short stock position) may become the proverbial Achilles heel. This is certainly not as safe as writing covered calls. With covered calls you have the luxury of holding onto the stock no matter how far it falls (of course, if you have used cash to buy the stock and not margin). With shorted stocks you don't have that luxury. If Ford continues to climb, you can be certain that your broker will force you to cover and that could mean substantial losses.

Uncovered (Naked) Puts - In this case you are writing put options without backing them up with short stock positions. The danger is obvious. If Ford is $40 come expiration time, you would be obligated to buy 200 shares of Ford at $50 putting you at a $10 per share disadvantage versus the current trading price. The more puts you have written and the more the underlying stock falls, the higher your losses.

As we learned previously, writing naked calls are much riskier than writing covered calls. The potential of loss with naked calls is unlimited as the underlying stock could climb indefinitely. But what about writing puts? Based on what we learned, it turns out that writing naked puts is actually safer than writing covered puts. The danger of covered puts is in the short position you have with the underlying stock. As the stock price rises, you will be in a good shape with regards to the put option you have written. But your short stock position puts you in a compromising situation where your potential loss is theoretically unlimited. Writing naked puts, while still risky, has a finite loss potential. If the underlying stock crashes to $0, you would have to buy the worthless stock at the strike price of the put options you had written. Your loss, however great, is only limited to the amount you have to pay for the worthless stock.

With regards to writing puts, your broker must qualify you first. You must not only demonstrate a sufficient comprehension of writing puts, …