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Using Naked Options System to Buy Options

By: OTS Team

Article Category: SML Options Trading

In some cases a trader who may have access to an uncovered options trading system, may not be willing to trade uncovered options, or is simply unable to do so because of margin requirements set by an options broker. In such case the question is how to adjust an uncovered options trading system to buy put and call options.

When a system generates a signal to sell short call options this system expects the market to move down and enabling a later buy of call options at a cheaper price to cover the short position. When the system generates a signal to sell short puts there is an expectation that the market will move up and and enabling a cover of the position through the buying of cheaper put options at a later time. This information can be used not just for trading uncovered options, however, a trader who wishes to use the system differently has to realize that this might involve additional risk, and the trader's return will differ from the return generated by the uncovered options trading system.

For instance if a trader decided to use the uncovered options signals to buy options it is recommended that the trader develop a trading strategy of following our signals. The following rules might be an example of such strategy:

• Buy calls when the system issues a signal to sell short puts;
• Buy puts when the system issues a signal to sell short calls;
• Close position when system closes position.

It appears simple at first sight, however a trader should always remember that the time decay affects the options price. Options have a tendency to loose the value with time and this favors the uncovered options trader. For a trader who buys options, the amount of time maintained in the position is critical and the trading strategy above should be followed with the following additional rules:

• Buy only in the money options (even if a system generates a signal for out-of-the-money options);
• If possible, buy options with later expiration than the system suggests for uncovered options;
• Think about closing a trade if a system stays in the position for more then 3 weeks ( time affects the options price and it's critical for the options buyer while it's in the hand of an options seller).

Of course this is only an example of rules which could be modified in accordance to personal trading style and risk tolerance. A trader should always remember that options trading is very risky and it is not recommended that traders invest an entire options portfolio in a single trade.