I enjoy participating in online discussions concerning options, and frequently visit and post at online forums. I recently encountered a suggestion that was so absurd, that I thought the poster was attempting to make a (poor) joke.
Nope. It turns out that he was serious. I hate the idea of publicizing his idea, but am doing so just to be certain every reader of this blog understands options well enough to run away – at warp speed – from anyone who suggests that you consider adopting a strategy that is in any way similar to this (I have no polite adjective to insert here) poster's idea.
I'm sure this warning is unnecessary, but just in case…
The idea? On expiration day, sell 10,000 options that are 'way out of the money' for the princely sum of $0.01 each. Yep, that's a total of $1.00 per contract – before commissions are deducted.
This joker believes that trade yields a profit of $10,000 per expiration – and apparently thinks it's free money. He actually calls this 'guaranteed way to make big, risk free money in options.'
Reality: Selling very cheap options is a losing strategy. Sure these options expire worthless almost all the time. Just think about the one time when this turns out not to be true. Stocks can, and do, make major moves in the final few minutes of trading on expiration Friday. Attempting to make such a tiny amount of money is financial suicide. Think about the loss if just one of these trades results in an option moving into the money. With 10,000 contracts, that costs $1,000,000 per point. Not only that, but can you imagine how your order to buy 10,0000 (now in the money) calls is going to affect the price of those options when the stock price is surging?
I understand this is an idea that will attract no followers. But what I fear is that someone might think it's a good way to pick up a few extra dollars by selling 10 or 20 contracts. Please don't do it. And if the price is $0.05 per contract, the idea is no better.
By the way, the margin requirement for selling naked call options does vary by broker, but a reasonable minimum is $250. (Many brokers do not allow the sale of naked call options under any circumstances.) Thus, it takes $2,500,000 to meet the margin call on this play. Do you think anyone who has two and one-half million dollars worth of free margin would jeopardize his/her account in an attempt to earn peanuts* ($10,000 less commissions)? I don't.
* Peanuts for that investor, not necessarily for the rest of us.