This Is Why You Don’t Sell Naked Puts
Over the weekend a tragedy occurred in Ethiopia when a Boeing 737 MAX 8, apparently fell out of the sky killing all 157 passengers and crew on board. It was the second crash in the past five months involving Boeings latest 737, a similar event happened in October when a plane owned by Indonesia’s Air Lion plunged into the sea killing 189. In both cases the crew reported that it was having trouble with the controls of the plane.
Boeing is trying to find the cause of problem that led to both crashes. The focus of the Air Lion crash has been on a possible computer malfunction of a sophisticated guidance system known as Maneuvering Characteristics Augmentation System (MCAS) which is designed to keep the plane’s nose from rising dramatically and causing a stall. The company is regenerating the software package so that the pilots now have the right to turn off the system if they suspect that it is malfunctioning.
Nothing can be done for the tragic events surrounding both crashes, but you would think that some traders or investors would learn that the market never announces itself. When an outside event happens the market simply prices itself and moves on. In many cases this type of price movement destroys investors from the retail level to large, multinational corporations that use a trade in which they sell naked puts to “enhance” the yield of their underlying stock.
On Monday morning, naked put sellers of BA woke up to a nightmare. Not only were they long extra shares of stock but unless they sold the naked puts $60 lower, they were long from as much as $60 higher. In my thirty-five plus years of trading options I have seen this bad dream arrive in many forms. Sometimes it was naked calls, other times it was puts, but the result was always the same. Do yourself a favor. If your want to enhance yield use weekly put and call spreads. Never sell naked options!
Ask Mr. Seifert
I am constantly asked questions about trading and how to exploit certain market factors to insure success. Each week I will answer one of those questions with a short paragraph which will cover the trading subject.
Question: What is the best way to initiate a credit spread?
Answer: Getting the spread on correctly is important. Novice traders can blow themselves up trying to get the “edge” on the market makers. Forget about that strategy because it won’t work. You are not going to be able to out execute the market makers. There are a couple of choices that will work when getting the spread in place. First you can “leg” the spread on by buying the long side of the trade first and selling the short leg. I use this strategy when I have a preference in market direction. I get my limited risk leg on first and then try to sell the credit side with more premium. Second, you can set your browser on your on line brokerage firm’s site to find out where the spread is trading in the market place. You should be able to get filled within a few cents either way once you know where the spread is trading. The third way which is always wrong it is to leg the spread on by selling the short option leg first. This is selling a naked option and will eventually result in a big loser. You are not going to beat the wise guys at their game. Eventually the impossible will happen and as soon as you sell the naked option Houston will get 50 inches of rain, and you will take a possible risk of $280 and turn it into $3000. You will then email me and tell me that I don’t know what I am doing and that the risk is much greater than I claim it is. Remember bulls and bears make money but pigs get slaughtered! Don’t be a pig. There is plenty of money to be made doing it the right way.
The Wise Guy Report: The View From The Floor
Each week I talk about what I think the Wise Guys (floor traders) are up to with the Big Three commodity contracts: Gold (GC), Crude Oil (CL) and Long-Term Interest Rates (ZB). I also track the Market Edge (www.marketedge.com) ‘Market Posture’ which has a twenty-six year record of forecasting the intermediate-term direction of the stock market as measure by the DJIA with around 70% accuracy.
T-Notes
Bonds have been bounced around for the past few months as the market tried to figure out the “Fed speak”. It appears that the market now feels that the Fed is going to keep its word and not have interest rates rise. In fact, they may keep them the same for quite some time. Based on this information, the ten-year T-Notes are experiencing a rally that could see them testing the yearly top at around 123.20. If they reach that level, I think it is a god spot to take profit and then take a shot from the short side. We have been long the 10-year and have a stop in at support as we don’t want to throw away a nice winner.
Crude Oil
After getting hammered last quarter when the market collapsed, liquid gold has seen a sharp turnaround. The problem is when market losses more than 50% of its value, it takes a 100% move to get back to the old high. Since its nadir on Christmas Eve, crude has rallied from a low of about $42 to its current level around $58. No matter how you look at it, that is a heck of a rally. Where we go from here is anyone’s guess, but it appears that we are in the start of a new bull run and maybe we can get up to the $76 level again. I decided to enter the market at nearby support at $55.05 and so far the trade has never looked back. Crude is now trading above $58 and appears to be in a breakout. With this head start, I have put my protective stop at breakeven ($55.05).
Gold
This has been a tough trade over the past couple of months. I bought Gold after that blow off bottom near $1165 back in September, but I didn’t get the expected results. The market was never able to take out the lows, so I stayed with the trade until it stalled around $1280. Looks like I took my profit too early as the market had more upside. I bought into a retracement and that trade is still in a holding pattern. If Gold is not going to rally from here, I will take my loss if long term support around $1275 is violated.
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The Market Edge ‘Market Posture’, which has been Bullish since the week ending 1/04/2019 (DJIA 23433.16) remains Bullish at this time.
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