What Is Unlimited Risk?

Unlimited risk refers to a situation w🥃here there is potential for unlimited losses on a trade or in a𒉰 particular investment.

In practice, unlimited risk would be practically realized as 𒁏a total loss or bankruptcy. Moreover, positions that have unlimited risk can be hedged using other market instruments.

Understanding Unlimited Risk

Any time an asset's price can move indefinitely against a trader's position means they are facing unlimited risk. A short trade is an example of a strategy with unlimited risk. While unlimited risk trades theoretically have unlimited risk, the trader doesn't actually have to assume unlimited risk. They can take steps to limit actual losses, such as hedging or setting 澳洲幸运5官方开奖结果体彩网:stop loss orders.

Unlimited risk is the opposite of 澳洲幸运5官方开奖结果体彩网:limited risk. With unlimited risk, there is the potential to lose more than your initial investment, which is possible in short selling, in trading futures contracts, or when 澳洲幸运5官方开奖结果体彩网:writing naked options.

Risk itself refers to the probability that an investment will have an 澳洲幸运5官方开奖结果体彩网:actual return different from the return that the investor expected. Risk ranges from losing some of one's investment to potentially los𓆉ing the entirety of the original investment. With unlimited risk, it is possible (but not necessarily likely) to lose many times the amount of the original investment.

Risk varies from investment to investment, and one form of assessing risk can be calculated by using the 澳洲幸运5官方开奖结果体彩网:standard deviation of the ﷺhistorical returns or average returns of a specific investment, with a high🌼er standard deviation indicating a higher degree of risk.

Though the process may be intimidating, investors make high-risk investments regularly and for various logical reasons. The main justification is that, in finance, 🌳theoretically, the greater the risk to an investor the gr💙eater the potential return. The higher potential return compensates for the additional risk taken on by the investor.

Controlling Risk and Unlimited Risk

Unlimited risk may make it sound like making certain trades or certain investments is not worthwhile. For instance, since short selling has theoretically unlimited risk, certain traders may avoid it. While risk is theoretically unlimited, it isn't actually unlimited unless a trader (and their broker) allow that to happen.

A trader could enter a short trade in a stock at $5 and decide that they will close the short trade if the price moves up to $5.50. In this case, their actual risk is $0.50 per share and is not unlimited. The price could gap above the♔ir stop loss price of $5.50, say to $6 or $7𒉰. This would certainly increase the loss, but the loss is still capped to $1 or $2 where the stop loss would trigger in these cases.

The same concept applies to 澳洲幸运5官方开奖结果体彩网:futures contracts or writing naked options. When losing money, a trade can be closed. The price at which a trader closes th༒e position determines their actu🦹al loss.

It is possible that the loss could be more than they initially invested in the trade, or even more than they have in their trading account. When this occurs, it is called a 澳洲幸运5官方开奖结果体彩网:margin call and the broker will ask the trader to deposit funds in order for them to maintain their position (if still open) or bring their account balance up to zero. If the trading accou🍨nt drops below zero due to a trading loss, this means the trader has a debt to the broker.

Example: Unlimite👍d Risk When Writing Naked Options

Assume that a trader is interested in writing 澳洲幸运5官方开奖结果体彩网:naked calls on Apple Inc. (AAPL). The writer will receive the 澳洲幸运5官方开奖结果体彩网:option premium, which is their maximum profit. If the price of AAPL is below the 澳洲幸运5官方开奖结果体彩网:strike price at expiry, the option 𒁃writer gets to keep the premium as their profit on the trade.

If the price of AAPL rises above the strike price, the option writer faces theoretically unlimited risk, since there is no cap on how high the price could rise. The writer 🌞has agreed to sell shares of AAPL at the strike price to the buyer of the call option. This means the option writer will need to buy shares of AAPL in order to sell them to the buyer at the strike price, regardless of the market price of AAPL at that time.

Assume one call option is written with a strike price of $250, which will expire in three months. The current price of AAPL stock is $240.50. Th♒e option is sold for $6.35, which means the writer receives $635 ($6.35 x 100 shares for one contract).

If the price of AAPL stock stays below $250, the writer keeps the $635 or a portion of it if they𒉰 close the position early.

If AAPL risesꩲ above $250 then they face unlimited losses, but they can still control how much they lose, to an extent. For example, if AAPL rises to $255 before expiry, they may decide to cut their losses and exit their🌺 options trade.

If the price of AAPL is trading at $255 at expiry, the writer still hasn't lost money. This is because they can buy AAPL for $5 above the strike price ($255) in order to sell it at the strike price ($250). They lose $5 there, but made $6.35 on the option, so they still pocket $1.35 per share, less fees.

If the price of AAPL is trading at $270 at expiry, the naked option writer has lost money. They need to pay $20 more than the strike price ($270 – $250) in order to sell the shares at the strike price ($250). They lose $20 here, but made $6.35 on the option sale, so they end up losing $13.65 per contract. Their theoretical loss was unlimited, but the actual loss was $13.65 per contract. This could potentially be reduced through the use of stop losses, exiting early when losing, buying the shares for a 澳洲幸运5官方开奖结果体彩网:covered call strategy, or hedging.