Strangles, Straddles, and Naked Options – Which Type of Trade Is Best?

Out of Strangles, straddles, and naked options-which type of trade is best? Naked options have a tendency to fall into the same category as simply buying options. If you have a bearish market bias, you sell calls; if you have a bullish market bias, then sell puts. While having a market bias is essential to anyone’s long-term success, trading that market bias can be dangerous, particularly when you have all or nothing riding on one premium. This is what selling naked options means.

If the trade fails, we know that selling options exposes you to unlimited risk. The worst-case scenario for a naked option seller is for the underlying asset to become lock limit against the option. The underlying asset cannot be exited, so the option’s volatility increases exponentially. The potential to lose thousands to gain a few hundred quickly becomes not worth it.

While there are ways to salvage or at least minimize the impact of a market moving against a naked option seller, it is best to have the proper option selling strategy set in place at the outset. This can best be accomplished by selling options only in sideways markets and using a sell straddle or sell strangle to let the market dictate what direction it wishes to go. This eliminates the need to have a market bias, while at the same time expanding your trading opportunities.

Naked option selling can be profitable. By monitoring the theta (decline of option time value) and the vega (measure of increase and decrease of option based on volatility), along with the expiration date, you can attempt to go through the option candidates and cherry-pick the ones most likely to sell. However, if you overoptimize your decision-making progress, you may find that there is not enough intrinsic value to make selling the option worthwhile.

When executing straddles and strangles then the same type of market bias as in selling naked options evolves from the market’s movement, not from any type of arbitrary decision-making process. Selling two options can be expensive, but it is a solid way to be able to participate in some of the most profitable options around. Theta and vega are also important, but there is no need to be 100 percent dependent on these two values in order to determine what options to select. They become secondary monitoring tools to reinforce a decision that the market has already made.