naked option

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Naked Option

An option contract without another, opposite option hedging the risk. Unlike more complex spreads and straddles, which involve the purchase or sale of multiple options in order to profit in different ways, naked options are straightforward calls or puts. An investor with a naked option makes a profit or loss depending on the movement of the underlying asset. Naked options are also called uncovered options. See also: Covered options.

naked option

An opening transaction in an option when the underlying asset is not owned. An investor writing a call option on 100 shares of IBM without owning the stock is writing a naked option. If the stock is called by the option holder, the writer must purchase shares in the market for delivery and is therefore caught naked. Also called uncovered option. Compare covered call option.

Naked option.

When you write, or sell, a call option but don't own the underlying instrument, such as a stock in the case of an equity option, the option is described as naked.

Similarly, you write a naked put if you don't have enough cash on hand or in liquid investments to purchase the underlying instrument.

Because you collect a premium when you sell the option, you may make a profit if the underlying instrument performs as you expect, and the option isn't exercised.

The risk you run, however, is that the option holder will exercise the option. In the case of a call, you'll then have to buy the instrument at the market price in order to meet your obligation to sell. Or, if it's a put, you'll have to come up with the cash to purchase the instrument.

If that price of the underlying has moved in the opposite direction from the one you expected, meeting your obligation could result in a substantial net loss. Because of this risk, your brokerage firm may limit your right to write naked options or require that you write them in a margin account.

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