I’ve made the majority of my trading profits from my weekly income selling weekly Naked Puts and Calls, but mostly calls. When I mention this to other traders, theta gang in particular, their reaction is one of concern, disgust, disbelief or some combination thereof. Selling naked gets a bad rap from traders that have gotten burned or downright wrecked in the past. Conventional wisdom is that shorting Naked Options is simply too dangerous. Eventually I’m going to “learn my lesson” and I too, will have my own come to Jesus moment and abandon the practice. It’s YOLO thinking and true disciplined trading inherently requires risk management.

While I can certainly attest to having gotten caught in a gamma squeeze or 2 myself (the last GME and that was not fun) I’m here to argue the case why selling Naked is preferable to traditional Credit Spreads or Strangles. Any trade can and often will require active management to stay successful. By being Naked, you have the advantage to employ your existing capital more effectively and defensively when your position is challenged. I believe Theta gang philosophy IS by far, the superior and safest way to trade. But being Naked has its place and before rendering me a heretic, here’s why and how I’ve reached this conclusion. Let’s start with Theta Gang’s 4 Disciples:

Here’s the 4 most popular theta gang strategies

1. Put Credit Spread
2. Call Credit Spread
3. Covered Puts / “The Wheel”
4. Short Iron Condor

The Problem with Credit Spreads

is simple. What if you didn’t need that protective call/put after all? Your net profit window is smaller by having to stay above the break even point. It also makes it harder to adjust the strike price if it needs to be managed. I understand having a defined maximum loss but the reality is you should always be using a maximum stop loss and in actuality you could be finding better entry points. While its true spreads are less capital intensive for traders that don’t have margin, this also provides the temptation to then sell more contracts when you otherwise wouldn’t.

The Problem with Strangles

Strangles are sold or were at least sold to me as a neutral strategy. But this seems counterintuitive to the method of profiting by collecting premium. Selling premium is most profitable when volatility is high, i.e. a large directional movement in price and/or demand for the asset. The more ballistic the move, the higher the IV. So if the price jumps way up, because of Gamma, the premium on calls is going to be much higher than the premium for puts. So selling a put credit spread after price just made a huge jump higher gives you shit for premium then exposes you to getting checked if the price comes back down. Same thing in reverse. So it’s not exactly "neutral" if one side is more vulnerable. Equally, if price has been trading sideways, usually the volatility is so low that there's not enough premium to justify even entering a position and if you do, you’re now vulnerable to sudden price movements.

TRADING NAKED

First things first. If Theta is Law, it stands to reason that contracts closest to expiration provide the best opportunity for time decay to work in our favor. Therefore I focus on selling weekly contracts; expiring at the end of the week. I look to find setups where price is heading towards a natural area of support/resistance, then sell a strike price that’s further OTM than said area, betting that it will be strong enough to slow or reverse price just long enough for the contract to expire worthless on Friday. If I can get 50-60% by Wednesday I take profit. I also put a .25 stop limit in too once I’m ITM because the same trade can always be reentered again and I can adjust entry to max changes in condition. Since the market has been going up and to the right pretty much since 2009, I have grown accustomed to selling calls simply because the Gamma for calls in a bull market is greater allowing for safer OTM entries.

To find support and resistance, I use a combination of moving averages, trendlines, and Fibonacci retracements, but there's one indicator that’s superior to all others in establishing price volatility. So much so that I use it as a condition for entering trades off top. The Bollinger Bands (i.e. Standard Deviations) give the clearest evidence to assess if price is at a level that’s historically overbought/oversold. The best thing is, you can backcheck in real time to see how price has behaved at the level in the past. I use 6 Bollinger bands, but for the case of naked trading here I’ll only focus on 2 and provide two examples, SPY and TSLA.

SPY is important because generally whatever the SPY is doing will have a greater impact on what the rest of the market does, and TSLA is an example for stocks notorious for volatility. Input the following 2 bands

For SPY WEEKLY CHART 1) 2.25, -2.25 2) 2.8, -3.7

For TSLA WEEKLY CHART 1) 2.8, -3.27 2) 3.7, -3.4

*Try it: YUR WEEKLY CHART 1) 3.5, -4 2) AHC, ALC

*Try this on your favorite equity. On a WEEKLY chart scroll back so #2 is just PAST the the highest (AHC) and lowest (ALC) all time weekly close. Mine lets me go back to 2002-3.

The significance in these values is, in my research (feel free to correct me if I’m wrong), there has been no historical weekly CLOSE above or below the #2 levels. Price has pierced but it has never CLOSED for SPY and TSLA respectively. Try it on another equity you trade frequently. Input these levels, and scroll back through time. See if you find any weekly closes above or below and just adjust the level/s accordingly to enclose it. I use the #1 as an alert level, once hit I reassess to look for further evidence of support/ resistance at this level and if everything checks out I sell ONE yes ONE contract AT #2 or FURTHER OTM strike. I start with one contract only so if the strike price gets checked, I have more capital available to deal with it.

CONTINGENCY PLAN

Lets say I sold a call and price is currently trading above my level. I have a few different options to keep the trade successful. Keep in mind, the fact I'm only in for one contract makes it much easier to manage, since the least amount of capital has been used thus far.

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1. ROLL UP: Vertical Roll- My go to if price is parabolic and/or i really want to exit the trade THIS week. Usually this requires selling additional contracts to roll up the position intraweekly to a further (ITM) strike price. I sell just enough to where credit for the roll is small or even zero. Creating more distance from the price gives me the best chance of the position expiring worthless by Friday.
2. SPLIT THE DIFFERENCE: Let's say the contract is currently $-400.00 I can roll the existing contract intraweekly or out to next week to a level high enough for a $200 debit then immediately sell a put (or divide into multiple puts) intraweekly for $200 or more credit effectively converting to a strangle. Because each side is smaller your strike can be further, improving chances of expiring worthless.
3. PUNT: Calendar Roll I can roll to the following week or weeks using the additional time premium to get a further OTM strike (or as above converting to a strangle with 2 contracts as in #2).
4. SWITCH SIDES: Roll the Call to an put of the same value. You can also increase the quantity but the less contracts the better. Now in fairness I don't normally do this at this particular moment where I established a strong directional bias.. BUT it IS an option at your disposal. There's times when conditions change, new event/info and my opinion on the trade direction completely flips . This is beautiful too because it just highlights the power of being an option seller. What other traders, can just at any moment, for any reason say "you know what, fuck it!" and immediately take the opposite side of the trade? That's like Shang Tsung level shit!!. Option sellers for life man I swear! ** I've discovered in talking to some traders that not all trading platforms allow you to change types (call to put, put to a call) in a roll order. That sucks! I use Tradestation it allows me to change the type, strike, quantity, and/or expiration all within one order. I highly recommend finding a brokerage platform that allows you to do this.
5. ASSIGN and REINCARNATE: A)Accepting assignment B) Sell new options collecting a premium amount > or equal to the amount the unrealized loss of the assigned shares C) exit the assignment shares position. I commonly hear traders when discussing the wheel say " I only sell puts at strikes I don't mind going long at". I 100% agree and I also agree a call position should be no different. I would never sell a call at a price I wouldn’t believe to be an optimal level to short. If it was a good level to go short then you shouldn't mind getting assigned and entering a short position. Its even happened a few times where when I checked back premarket on Monday the following week, because of premarket movement my assigned short shares were ALREADY in profit. However If you’re still negative, you can supplant the unrealized loss with new credit and as long as you do this intraday- the account size will not change. *** Its also worth noting that once I've decided that FRIDAY that accept assignment , I can and usually do sell a couple more OTM strikes that day to take advantage the gamma run up to lock in some small gains by the close which can also offset if not completely cover the amount the shares are negative come Monday morning

SUMMARY

Naked trading is possible with a stringent entry criteria. Is there risk ? YES! We’re traders! There's risk in everything. But at the end of the day a naked short is nothing more than a getting paid to place a limit order. Don’t long or short a price you wouldn’t already be comfortable going long or short at. My personal criteria for enter ANY position.

1. I only sell positions when price at a historically verified overbought/sold levels via the Bollinger band. It has to be at or past level #1 then I sell the #2 level or further OTM
2. I only sell one contract to start, to allow greater freedom if the trade needs to be managed.
3. I manage the damn trade! A 50% win in half the time or a .25 ITM stop out is STILL a W. There’s always another trade to make. If the trade needs to be defended, use the changes in condition and your account to find the best course of action. If you get assigned you can always supplant the existing loss amount with new premium on a new trade. Realized loss only occurs when intraday daily credit is less than the debit.

NEW TRADERS- It should be noted, going back to using the Bollinger Band #1 levels as a MANDATORY condition for even considering entering the trade is the really the crux of the whole argument and can not be stressed enough. Furthermore that's just the first step. You really need more evidence of support/resistance to justify taking the position. Keeping the criteria for entry strict to severe price extreme is what makes this conservative and if you don't follow it you're just being reckless and you will most likely get wrekt. For me, this makes my life super easy because if price is not at or over that first level I DON’T TRADE IT! period. It’s that simple. And then I make it a point to sell a contract even further OTM at level #2 to further minimize risk. I suggest you try this criteria on your own equities that you trade often. Adjust the #2 past the the furthest weekly close on the high side and the low side and maintain this as a basic guide, it'll keep your ass out of so many bad trades. I can’t stress that enough. Some other things to consider;

Keep trade sizes low and only trade the equities your account can handle.

Never sell options BEFORE earnings; try a small OTM long straddle instead if you wanna play the lotto. Avoid selling calls on heavily shorted stocks (>20% float)