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Chapter 3. Options in Context > Short Positions, Naked or Covered

Short Positions, Naked or Covered

The concept of speculating on long calls or puts is contrary to the generally understood definition of conservative. As shown in the preceding discussion, there may be moments when you want to use long calls or long puts to take advantage of price changes. It is appropriate, given the timing, and may conform to your conservative standards. For example, if you bought stock and currently have a large paper loss, buying calls is one way to average down your basis. If you can acquire additional shares of stock at a strike price below your original basis, it could bring the collective value up high enough to eliminate those paper losses. This is the opposite side of the coin in which you would buy puts to protect paper profits. If the stock were to decline in value, you could sell the puts, creating a profit to offset stock losses; or you could exercise the puts and sell shares of stock at a price higher than current market value.

Some strategies involving short calls and puts may also conform to your conservative risk profile based on prevailing market conditions and your portfolio positions. The basic covered calls strategy is the most obvious example. When you sell a call, you are taking paper profits and reducing your basis in the stock; you expose yourself to the possibility of losing future price gains in exchange for the certainty of premium income today.


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