#1 – Set a Bailout Point and Use It
A bailout point is the price, or the point in your strategy, at which you wish to buy back your naked positions in order to limit your losses. This is the point at which you will bite the bullet if things don’t go your way, and it is the most important component of your naked option writing strategy. You must use this as a safeguard to limit your losses and control the tremendous risks involved with this strategy.
As an options writer, you have the right to go into the market at any time and buy back your naked options, thereby limiting all possible future losses. Setting a bailout point is a way of insuring that you will use this right when the price hits the parameters you have set. I strongly recommend using a stop-loss order rather than a mental stop. And it is better to set your stop-loss based on the underlying stock’s price, as opposed to the option’s price, as options prices are more erratic, and in many cases, they may become extremely inflated, even though the stock price has not moved accordingly.