I want to go over a common concern with futures options trading. I only recommend and teach selling options if you are covering them by buying options. Sold options that are not covered are called “naked options”. That means that if there is a move against you, and you did not also buy options, there is potential unlimited loss.
If you did cover your sold position by buying a future option as protection, you are no longer naked. Now even if a sold option is covered some still feel nervous if an option they sold is exercised into a futures contract. The buyer of an option has the right at any time to exercise their option. Let’s assume you sold a call option to someone. They exercise the option and now they are long a futures. That means you are now short the futures. Should you be concerned?
Two things to consider:
You have unlimited loss potential whether you are selling a futures option or long or short a futures contract. So the fact that someone exercises an option should not worry you more. Either way, there is unlimited loss potential. But you always want to cover the position. So either way, now that it is covered, you do not have unlimited loss potential.
The second thing is that you should be happy because if the seller exercises the option if there is still time value left. When they do this, they are giving up on some of the time value. So if there is $100 time value left and the buyer exercises the option, he gives up that time value when he gets the futures. So either way, do not worry if you are protected.
If you only sell uncovered or naked options because you do not want to spend the money to buy options as protection, you might want to re think your strategy. Find cheap options to cover your sold options instead of being naked.
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