Key Takeaways
- Sell call option without owning underlying asset.
- Profit limited to premium received.
- Risk of unlimited losses if stock price rises.
- Requires high margin and suits experienced traders.
What is Naked Call?
A naked call is an options strategy where you sell a call option without owning the underlying asset, exposing yourself to potentially unlimited losses if the stock price rises sharply. This call option selling is also known as an uncovered or short call and is typically used when you expect the stock to stay flat or decline.
Unlike covered calls, a naked call requires no stock ownership but demands significant margin from your broker due to its high risk.
Key Characteristics
Understanding the core traits of a naked call helps clarify its risk and reward profile.
- High risk, limited profit: Your maximum gain is the premium received, but losses can be unlimited if the stock surges.
- Margin requirements: Brokers impose strict margin rules, often leading to a margin call if the position moves against you.
- Time decay benefits: The option's value erodes over time, favoring the seller if the stock price remains below the strike.
- Assignment risk: You may face early exercise by the option buyer, forcing you to buy shares at market price to deliver at the strike.
How It Works
When you sell a naked call, you collect the premium upfront, obligating you to sell 100 shares per contract at the strike price if exercised. Since you don't own the shares, you must purchase them at market price if assigned, which can lead to substantial losses if the stock price rises significantly.
The strategy profits when the underlying stock stays below the strike price, allowing you to keep the premium as income. Time decay and declining implied volatility work in your favor by reducing the option's value, making it cheaper to close the position early if needed.
Examples and Use Cases
This strategy is often employed by traders anticipating a neutral or bearish stock outlook.
Important Considerations
Due to the risk of unlimited losses, naked calls require careful risk management and are best suited for experienced traders comfortable with high-risk strategies. You should monitor your positions closely to avoid unexpected margin calls and be prepared for potential early exercise scenarios.
Incorporating technical analysis can help identify optimal strike prices and timing to improve your success rate with naked calls.
Final Words
A naked call offers limited profit potential with significant risk if the underlying asset rises sharply. Carefully assess your risk tolerance and margin requirements before implementing this strategy. Consider consulting a financial professional to evaluate if this fits your portfolio goals.
Frequently Asked Questions
A naked call, also called an uncovered or short call, is an options strategy where a trader sells a call option without owning the underlying stock. The seller collects a premium but faces unlimited risk if the stock price rises above the strike price.
The seller profits if the underlying stock stays below the strike price until expiration, allowing the option to expire worthless. The maximum gain is the premium collected when selling the call.
The biggest risk is unlimited potential losses if the stock price rises sharply, as the seller must buy shares at high market prices to fulfill the contract. There is also risk of margin calls and early assignment.
A naked call involves selling a call option without owning the underlying shares, exposing the seller to unlimited loss. A covered call requires owning the stock, which limits risk since the shares can be delivered if the option is exercised.
Because of the high risk and potential for unlimited losses, brokers require significant margin—often 20-30% of the underlying stock’s value—to ensure the seller can cover potential obligations.
Naked calls are suitable only for experienced traders comfortable with high risk and margin requirements. It’s a bearish to neutral strategy betting that the stock price will not rise above the strike price before expiration.
Time decay works in favor of the naked call seller, as the option’s extrinsic value declines as expiration approaches. This can accelerate profits if the stock price remains below the strike price.
If the stock price exceeds the strike price, the buyer may exercise the option, forcing the seller to buy shares at the higher market price and sell them at the strike price, resulting in a loss equal to the difference minus the premium received.
