How Naked Call Works

The naked call is possibly the riskiest investment for investors that are looking for strategy options. That is because the investor is required to buy the original stock at the current market price. Since stocks' cost is constantly increasing, the investor can lose a large amount of money. If an investor sells off a call option, they must be the risk bearer to sell shares of the original stock before the expiry date. Because a naked call is a risky strategy option, only experienced investors should choose it.

A naked call is a risky strategy option that can result in loss. If the stock price exceeds $45 and the current price is $60, the investor must purchase 100 shares of the stock at $60. It would be best to remember that the investor has sold these shares for $45 each. So for each share sold, the investor losses $15. So $15 × 100 shares = $1650. If we minus the premium of $110 from $1500, the investor has lost the sum of $1400.

Example of Naked Call

If the stock's current price is $30 and the investor doesn't believe that the price will increase to $45, the investor might sell a naked call option of $45. When completed, the investor receives a premium worth $100 for the option.

The investor believes that the price of the stock will not be more than $45. If the stock price doesn't exceed $45, the investor gets to keep the premium that is worth $100 in this case.

Types of Naked Call

There are two types of Naked Calls: the short call and the short put.

  • Short call: When an investor sells a short call, he or she is required to sell 100 shares at the naked call's price if the option is selected before its expiration. If you place a short call, it is a risky strategy option because there is no limit to the stock's maximum price.
  • Short put: If you sell a short put, you are required to buy 100 shares of the stock at the current market price if the option is selected before its expiration. It is also a risky strategy option as the stock's current market price can drop down to $0.00 for each share.

Although there are two types of naked calls, a naked call refers to all short calls. However, you may find terms such as long naked options. To understand this clearly, you should look out for words that indicate sell, buy, credit, debit, short and long.

Naked Call vs. Covered Call

In a naked call, commonly called a short call, an investor expects or hopes that a stock's current market price will drop. This type of strategy option is the riskiest and used mainly by experienced traders. The maximum profit you can get is the premium received, while the maximum loss is unlimited.

On the other hand, a covered call is a strategic option used by investors to protect their shares. For example, you can own a company's shares and still sell a call option from that same company. However, the call option won't be active until the current market price of the stock increases. If you own a share and believe that its current market price will increase, you can select a call option. Both the call option and the premium received are your profits.