Retail traders mostly go long on options whereas professional traders typically use options to capture time decay. That is, they initiate short option positions that combine with their primary position which may be futures contract. Some retail traders create naked short positions. They base their argument on empirical evidence that about 85 per cent of the out-of-the-money (OTM) options expire worthless. This week, we discuss the risks you should be aware of before initiating a naked short position. Skewed returnsArguing that 85 per cent of OTM options expire worthless does not give a complete picture. Reports suggest that about 70 per cent of the traded option contracts are closed before expiry. Of the remaining contracts that are carried till expiry, about 15 per cent end in-the-money (ITM). The remaining 85 per cent expire worthless. The probability that the option you short will expire worthless is very high, but the magnitude of gains is low. This is because the maximum gains you get from shorting is the premium collected when you initiate the position. The probability that the option you short will expire ITM is low, but the magnitude of loss is high. In other words, short option strategies have a negatively skewed returns distribution. That is, you make small frequent gains but large infrequent losses. You should prefer a positively skewed returns distribution. The issue is that prices can jump. That is, an underlying price can gap-up or gap-down. Whereas gap-down may lead to modest gains, gap-up can push an OTM call into ITM. That is an issue because intrinsic value of a call option moves one-to-one with the underlying. That causes significant losses, as the increase in an option price from intrinsic value (loss for shorts) is more than the decrease in price due to time decay (gain for shorts). Combining short option positions with a primary position helps you manage the risk of loss and yet provides the opportunity to capture gains from time decay. Importantly, it reduces trading capital because of cross-margin benefits offered by the NSE.Optional readingWhen the underlying moves up, call delta will increase, boosted by its gamma. Only the theta works against a long position. We ignore the vega effect for this discussion. In contrast, when an underlying declines, call delta and theta work against the long position with the gamma working in its favour. Now, delta is a more significant factor than the gamma. Therefore, the long call position loses significantly when the underlying declines. A short call position has the opposite effect – potential gains are more than losses, for a given change in the underlying. This tempts traders to create naked short positions. The issue is that an underlying can go up sharply, resulting in significant losses to the short position (short delta and gamma).The author offers training programmes for individuals to manage their personal investmentsPublished on July 18, 2026