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Measure content performance. Develop and improve products. List of Partners vendors. A naked option is created when the option writer seller does not currently own any, or enough, of the underlying security to meet their potential obligation. A naked option, also known as an "uncovered" option, is created when the seller of an option contract does not own the underlying security needed to meet the potential obligation that from selling—also known as " writing " or "shorting"—an option.
In other words, the seller has no protection from an adverse shift in price. Naked options are attractive to traders and investors because they have the expected volatility built into the price. If the underlying security moves in the direction opposite to what the option buyer anticipated, or even moves in the buyer's favor but not enough to for the volatility already built into the price, then the seller of the option gets to keep any out-of-the-money OTM premium.
Typically, that has translated to the option seller winning around 70 percent of trades, which can be quite appealing. Selling an option creates an obligation for the seller to provide the option buyer with the underlying shares or futures contract for a corresponding long position for a call option or the cash necessary for a corresponding short position for a put option at expiration.
In the case of a seller who sold a put option, the ultimate effect would be to create a long stock position in the option sellers —a position purchased with cash from the option sellers . If the seller has no ownership of the underlying asset or the corresponding cash necessary for the execution of a put option, then the seller will need to acquire it at expiration based on current market prices. With no protection from the price volatility, such positions are considered highly vulnerable to loss and thus referred to as uncovered, or more colloquially, naked.
A trader who writes a naked call option on a stock has accepted the obligation to sell the underlying stock for the strike price at or before expiration, no matter how high the share price rises. If the trader does not own the underlying stock, the seller will have to acquire the stock, then sell the stock to the option buyer to satisfy the obligation if the option is exercised.
The ultimate effect is that this creates a short-sell position in the option sellers on the Monday after expiration. For example, imagine a trader who believes that a stock is unlikely to rise in value over the next three months, but they are not very confident that a potential decline would be very large.
They decide to open a naked call by "selling to open" those calls and collecting the premium. In this case, the trader decides not to purchase the stock because they believe the option is likely to expire worthless and the trader will keep the entire premium.
There are two possible outcomes for a naked call trade:. As you can see in the preceding outcomes, there is no limit to how high a stock can rise, so a naked call seller has theoretically unlimited risk. With naked puts, on the other hand, the seller's risk is contained because a stock, or other underlying asset, can only drop to zero dollars. A naked put option seller has accepted the obligation to buy the underlying asset at the strike price if the option is exercised at or before its expiration date.
While the risk is contained, it can still be quite large, so brokers typically have specific rules regarding naked option trading. Inexperienced traders, for example, may not be allowed to place this type of order. Essentially, a seller who sold a put option is liable to have a long stock position if the option buyer exercises.
Advanced Options Trading Concepts. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any . These choices will be aled globally to our partners and will not affect browsing data. We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. What Is a Naked Option? Key Takeaways Naked options refer to an option sold without any ly set-aside shares or cash to fulfill the option obligation at expiration.
Naked options run the risk of large loss from rapid price change before expiration. Naked call options that are exercised create a short position in the seller's . Naked put options that are exercised create a long position in the seller's , purchased with available cash.
Compare s. The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Related Terms Uncovered Option Definition An uncovered option, or naked option, is an options position that is not backed by an offsetting position in the underlying asset. Naked Put Definition A naked put is an options strategy in which the investor writes sells put options without holding a short position in the underlying security. Naked Call Definition A naked call is an options strategy in which the investor writes sells call options without owning the underlying security.
Naked Writer A naked writer is a seller of call and put options who does not maintain an offsetting long or short position in the underlying security. Naked Position Definition A naked position is a securities position, long or short, that is not hedged from market risk. Pin Risk Definition Pin risk is the uncertainty that the writer of an options contract faces when the price of the underlying asset closes at or very near the strike price at expiration. Partner Links. Related Articles. Investopedia is part of the Dotdash publishing family.Nude trader
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