lystn

Hey everyone, Kirk here again and welcome back to the daily call. On today’s daily call, we’re going to talk about how you determine breakeven points for naked calls and puts. This really gets down to I guess the basics of options trading and something that I don’t think actually even people who have traded options before remember. Sometimes you forget because I get emails from people and they say, “Kirk, I’m trying to figure out where my breakeven points are.” It just comes back down to really actually just simple math and maybe sometimes, just slowing down are not rushing through the process. But in the case of naked calls and puts and we’ll start with naked calls to start. Again, with all naked option selling or all option selling in general, you take in a credit and that credit is then used as the basis for helping to determine where your breakeven points are. In the case of a naked call, let's say that the stock is trading at $95. You sell a naked call at 100 strike, but you take in a $3 credit. Now, obviously, your option technically goes in the money if the stock goes from 95 to anything above 100. Let’s say it starts going up and it goes to 101, so it’s rallied from 95 to 101. You sold the 100 strike calls, so technically, that option contract is in the money. Now, most people would just quickly close the position which is the wrong thing to do or they would try to use a stop loss or something like that, fearing that they might be assigned or they might be at risk of assignment. But again, your breakeven point is actually the strike price of the short strike you sold, so the 100 strike price, plus the credit that you took in. In this case, for the naked call option that we’re using as an example, we took in a credit of $3. We add $3 to our short strike price and that makes our breakeven point for a naked call, 103 on the actual stock. If the stock rallies above 103, that's the point at which we actually start losing money. If the stock rallies to 101, we actually still made money. We made $2 on that trade assuming it’s at expiration because the stock rallied to 101. Basically, we have an option contract that’s in the money by $1, but we collected $3, so we still make our $2 profit on that. Again, that's why breakeven points are really important for factoring in and determining as you make your trades, so you know exactly where you make or lose money and it doesn't necessarily have to be when the stock goes in the money or not. Now, on the naked put side, just to use that example, let’s say the stock is again, trading at $95. We sell the 90 strike put option below the market and again, collect $3. Now, in the case of a naked put, you determine your breakeven point by taking your short strike price, so $90 in this case and you subtract the credit that you received because you're selling puts, so you subtract the credit that you receive and now, you take that $3 credit off of 90 and you're left with a breakeven point of $87. Again, if the stock falls and let’s say it falls to $89, so it goes $1 in the money, you still have the ability to make $2 on that trade because your breakeven point is $87 and the stock is only trading at $89. Now, in the case of combining these two because we only talked about in this example just a single naked call versus a single naked put. But let's say now that you actually… We’ll take it a step further in this. Let’s say that you actually now sold the strangle, so you sold the naked call and the naked put. You sold the calls for $3, you sold the puts for $3, now you have this collective $6 premium. Now, you still take that $6 premium and add or subtract it to your short strikes. What that does is it moves your breakeven points that much further out on either end. Now, you add $6 to your 100 strikes, you’re at 106. You subtract $6 from your 90 strike put, so you're basically at 84. Now, you’ve got a much wider range that the stock can fall into because you’ve taken in these additional credits. Hopefully this podcast has been helpful. Again, I know it’s something that oftentimes maybe gets missed or slips over and you just don't really think about it that way, but maybe using this example just brings that back to home and helps you understand how different strategies work, especially as you start using more advanced strategies like iron butterflies and short straddles. As always, if you guys have any questions or comments, let me know. Until next time, happy trading!