Naked Call Writing

| December 8, 2011 | 0 Comments

First and foremost… naked call writing is the most dangerous strategy in the options market.  It leaves you (the seller) open to unlimited exposure.

To begin… what’s a naked call option.

In brief…

A naked call option is an option that’s sold for a premium without owning the underlying security.  So, a naked call writing subjects you to unlimited risk.

Let’s look at how…

Imagine you write (sell) a Microsoft April $25 strike call option.  Since you are the seller, you’re obligated to sell 100 shares of Microsoft for $25 at any time before Aprils expiration.

Here’s the thing… you don’t own any Microsoft stock.

Now what, you’re obligated to sell 100 shares of a stock you don’t own.

You’re now forced to go buy 100 shares of Microsoft in the marketplace so you can sell them per your obligation.

Here’s the kicker… let’s say Microsoft is trading at $100 per share.

Bottom line…

If your naked call option is assigned, you must sell your stock at $25.  Since you don’t own it, you have to go buy it for $100 and then turn around and sell it for $25.

Just to be absolutely clear… you just lost $75 a share or $7,500 per contract.  If Microsoft somehow soared to $1,000 per share, the same would be true.

Well… let’s not end on a down note… there’s another scenario.

If Microsoft never reaches $25 dollars, you simply keep the premium.  The reason this would happen is if Microsoft was trading at $20, no one would want to buy the stock from you for $25.

So, don’t forget… this is the most dangerous strategy.  If you’re going to use it, check with your broker first.  Some brokers won’t even all this trade, and if they do, there’s substantial margin requirements behind it.

 

Category: Options Trading Strategies

About the Author ()

A former banking executive, Corey Williams is the Chief Options Strategist and co-editor of our well-known daily newsletter, Options Trading Research. Corey’s extensive experience with options goes all the way back to his days in corporate finance. It was this decade in banking where Corey discovered the most important skill an options trader can have– the ability to analyze a company or sector to determine its likely future direction. And now he’s brought this background, experience and love of options to Options Trading Research, the unique daily e-letter devoted exclusively to helping individual investors profit from the very lucrative options market.

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