Business, Legal & Accounting Glossary
A naked option is an option contract that creates potentially significant exposure because the option writer does not have an offsetting position. For instance, if an investor sells a call option for a stock without owning shares of that stock, the call is said to be a naked option. If the call option is exercised, the naked option writer must buy shares at the market price, no matter how high, then sell those shares at the strike price. This type of naked option is sometimes called an uncovered call. Similarly, the uncovered put is a naked option contract in which the writer does not have a short position in the asset. If the put is exercised, the writer of this naked option will be forced to buy shares for above market price. A naked option can be extremely profitable provided the price of the underlying moves in the right direction. Writing a naked option is an extremely speculative investment.
An opportunity to buy stock at a fixed price, offered by a seller who does not own the stock to back up the promise. If the buyer wants to exercise the option, the seller must purchase the stock at market price to make good on the offer.
When you write or sell a call option but do not own the underlying instrument, such as a stock in the case of an equity option, the option is said to be naked. Similarly, if you don’t have enough cash on hand or in liquid investments to purchase the underlying instrument, you write a naked put. Because you receive a premium when you sell the option, you could profit if the underlying instrument performs as expected and the option is not exercised. However, you run the risk that the option holder will exercise the option. In the case of a call, you will then be required to purchase the instrument at the market price in order to fulfil your obligation to sell. If it’s a put, you’ll need to come up with the money to buy the instrument. If the underlying price has moved in the opposite direction of what you expected, meeting your obligation could result in a significant net loss. Because of this risk, your brokerage firm may restrict your ability to write naked options or require you to do so in a margin account.
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This glossary post was last updated: 5th April, 2022 | 0 Views.