A naked call, or uncovered call, is an aggressive, high-risk option strategy. It occurs when an investor sells or writes call options for which they don’t own the underlying security. The seller is betting that the underlying stock price will not increase before the call’s expiration date.
It is safer for traders to sell calls on a stock they already own. This way, if the stock price increases sharply, the trader’s net position is hedged. A hedged position , in this example, means that as the stock value rises, the long-stock position grows while the short-call option position loses. This situation describes a “covered call” position, which is a much lower risk strategy.
Naked calls, on the other hand, are speculative trades. You keep the premium if the underlying asset is at or in the money at expiration, but you also have the potential for unlimited losses. Read on for more about what naked calls are, how they work, their risks and rewards, and more.
Understanding Naked Calls
When a trader sells or writes a call option, they are selling someone else the right to purchase shares in the underlying asset at the strike price. In exchange, they receive the option premium. While this immediately creates income for the option seller, it also opens them up to the risk that they will need to deliver shares in the underlying stock, should the option buyer decide to exercise.
For this reason, it is significantly less risky to use a “covered call” or sell an option on an underlying asset that you own. In the case of stocks, a single option generally represents 100 shares, so the trader would want to own 100 shares for each option sold.
Trading naked calls, on the other hand, is among the more speculative options strategies. The term “naked” refers to a trade in which the option writer does not own the underlying asset. This is a neutral to bearish strategy in that the seller is betting the underlying stock price will not materially increase before the call option’s expiration date.
In both the naked and the covered scenarios, the option seller gets to collect the premium. However, selling a naked call requires a much lower capital commitment, since the seller is not also buying or owning the corresponding number of shares in the underlying stock. While this increases the potential return profile of the strategy, it opens the seller up to potentially unlimited losses on the downside.
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