Difference Between Naked Option & Covered Option

Difference Between Naked Option and Covered Option




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Covered Options Vs Naked Options

Some options trading techniques rely only on options with no underlying assets, whilst others mix stock holdings with options. Finding the optimal method for your requirements boils down to risk against return and whether you like to be "covered” or "naked."

What is a Naked Option?

When you possess naked options, you own the option but not the underlying security. You can't execute the option without the underlying security, but it doesn't imply you can't profit from it. You may still charge a premium for the option.

For example, if you sell a put option but do not own the underlying stock, you have a naked put position. Naked option sellers and naked option buyers exist. The level of risk you're prepared to accept determines whether you purchase or sell naked options.

What is a Covered Option?

Selling covered options is an alternative to selling naked options. Selling covered calls are more common than selling covered puts. This is because investors are more likely to hold the underlying securities when they purchase a covered call. When you sell a covered call, you earn money regardless of whether the price:

  • Moves down
  • Moves up
  • Moves sideways

A covered call strategy pays you while you hold the stock and may increase your income if the stock is a dividend-paying firm. You combine your stock and option holdings wIn addition when you sell a covered put. This helps you to accumulate money while mitigating dangers.

Which is Better, Covered or Naked?

Selling options, whether covered or naked, may present you with substantial earning prospects. While the risk profiles of naked and covered options vary, each may offer distinct advantages.

Although the initial expenses of selling naked puts may be lower than those of having a covered position, you would forgo the extra dividend income that comes with owning a covered call position. Both techniques are appropriate for an income-generating portfolio. This allows you to develop a risk profile that performs well in a market that swings up, down, and sideways.

How Can You Use Covered Options in Conjunction With Stocks?

Adding covered calls to your stock portfolio alters some of the variables, most notably your risk profile. If you are thinking about increasing income or currently have a dividend income plan in place, adding covered calls can improve your results.

You will benefit from more protection against a decline in the share price of the companies you buy, but this comes at a cost. If stock prices rise, you forfeit part of your profit. Those aiming just for capital gains might increase their profits by determining their take profit (the price at which they cash out) and obtaining more income if the price climbs to that level.

Wrapping Up

Contrary to common assumption, futures and options trading is not as tricky as they seem. You will utilise these cutting-edge financial products more effectively if you have a thorough grasp of them. Having a Demat and trading account is essential if you are trading derivatives or investing in upcoming IPOs. If you don't already have one, go to Motilal Oswal right now and open a free demat and trading account.

 

Related articles: How to Open a Demat Account Without a Broker | Factors to Keep in Mind While Opening a Demat account | All about options trading in commodities | Futures and Options trading and how to make money | Using options to play a bearish equity market

 

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