Bracket Trading Techniques

Leveraging your buying power for the big move

Unlike covered calls, where the option seller owns the underlying stock, the writer of naked calls remains completely exposed to upside risk. Nevertheless, if you are comfortable using this strategy, it is most effective using current (near-term) month options because they decay more rapidly. And that's what you want. The faster these options become worthless, the better.

To see how this works, consider the following:

Stock price: $87
90 call: $6

By selling the 90 call at 6, you would receive the $600 option premium, your maximum profit. At expiration, if the stock is at or below $90, you keep the full $600. However, your profit disappears as the stock climbs toward $96. Above $96, your loss grows without limit.

Value at Expiration
Stock Price	Profit (Loss)
$80	$600
$90	$600
$96	0
$100	($400)
$110	($1,400)
$120	($2,400)
$130	($3,400)

Given the mounting losses apparent in the table above, it should be clear the naked call writing is an extremely risky strategy. Even the most bearish investor would do well to convert this position to a bear call spread by buying an out-of-the money call. This would limit upside losses.