Sunday, December 2, 2018

How Karen the Supertrader Blew Up Her Accounts

There's nothing wrong with trading Naked Puts, but Karen the Supertrader did what almost every novice naked option trader does: If your position size is too high, you too will blow up your account.

Selling Naked Puts like Karen the Supertrader:

Suppose you sell a naked put for $1.00. Then the stock goes down and now that put trades for $2.00. So instead of showing a loss of $1.00, you roll that option out in time for let's assume a net of $0.50. So where you had a loss of $1.00 ($2.00 less $1.00), you're now showing a gain of $0.50 (-$2.00 to buy back the NP and +$2.50 to sell the new NP). So while you're actually losing money on the underlying position, you're showing a gain by rolling that position out in time. With Karen taking commissions on the "gain" of $0.50, she's taking credit for a gain that may never be realized, or worse.

If you can keep rolling this position long enough, you may be able to get out of the position without a loss even if the stock never goes back up. But if you are highly leveraged and your position size is too high, you can quickly blow up your account when the stock swoons and you too can't meet your margin calls.

This is what happened to Karen the Supertrader. Margin calls came in on the leveraged positions, and she could not meet those calls. She could not hold on to those positions long enough to hopefully see a reversal in the underlying.

Naked options by themselves are not a bad thing. The problem is leverage and position sizing. I don't use leverage when trading Naked Puts.

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