What is a Naked Call?
In finance, options are contracts that convey they right, but not the obligation, to sell a stock at a certain price at a certain time. A call option is purchased as a way to potentially profit from a rise in the price of a stock above a certain level. The seller of the option can sell it in two different ways, commonly called naked and covered. A covered option means that the investor who is selling the option owns the underlying stock. A naked call option, also known simply as a naked call, is more speculative and risky, because the seller does not own the underlying stock, and is therefore exposed to theoretically unlimited loss. A naked call and a covered call have more in common than not, but it is the one big difference between them that is the source of the risk. For any call option, the seller does not believe that the price of the stock or other instrument will rise above a certain level, called the strike price, in the near future. The buyer of the option disagrees, and plans
You write a naked call when you sell a call against securities that you don t own. This is one of the riskiest of market transactions, because, as the writer — or investor — your risk is unlimited. The owner of a call option has the right (but not the obligation) to buy the specified security at a set price for a particular period, usually a few months. He might buy a call if he expects the underlying investment to rise in value. The person who sells the option is known as the option writer, who receives in return a nonrefundable payment called a premium. If you sold a naked call and the option owner exercised his right to buy the stock, you must buy the called shares in the open market — no matter what it s selling for. There is no limit to how high this price could go. If you do own the security, on the other hand, you ve written a covered call.
