What Are Naked Options? Types Of Options: Call & Put

What Are Naked Options

What is a Naked Option?

A naked option is a financial phrase that refers to an investor who sells an option without maintaining a comparable stake in the underlying securities. Selling naked options is considered a high-risk trading strategy since it exposes the investor to significant risk while yielding a small reward. Nonetheless, since most options expire worthlessly, it is a method many traders use. Selling options may therefore be a successful strategy.

Covered Options Vs Naked Call & Put Options

As previously stated, a naked option is the sale of an option without the seller holding a comparable stake in the underlying securities. A covered option, on the other hand, is one that is offered by a seller who does possess a comparable stake in the underlying securities.

Investor A, for example, is considered to be selling a covered option if he already owns 100 or more shares of Stock A and subsequently sells a call option on the stock. Selling a covered put option would need the seller already having a short position in the market by selling 100 or more shares of the underlying company short. The need for 100 shares is due to the fact that conventional stock options are options on 100 shares of the underlying stock.

If the option seller has a market position of fewer than 100 shares, his option selling will be only partly covered. Selling a covered option eliminates the risk of selling the option while limiting the seller's potential profit in the underlying stock to the option's strike price.

Naked Call Option

The buyer of a call option hopes to benefit from an increase in the price of the underlying securities. A call option gives the buyer the right to acquire a certain quantity of the underlying securities at the option strike price before the option expires. The buyer pays the option seller a fee known as the "premium." The option seller's most significant possible profit from the deal is the premium earned for selling the option.

Naked Put Option

The buyer of a put option hopes to benefit from a drop in the price of the underlying securities. A put option gives the buyer the right to sell a certain quantity of the underlying securities short at the option strike price before the option expires. The buyer, like the seller of a call option, pays a premium to the seller of the option. The option seller's most significant possible profit from the deal is the premium earned for selling the option.

Why Choose Naked Options?

Naked options are often offered by speculators who are very bullish on the direction of an index or the price of a stock. And, if the market turns against them, they may attempt to rescue the situation by acquiring similar but opposing options. They might also consider having a position in the futures market to offset the losses from selling a naked call or put.

Wrapping Up

Contrary to popular belief, trading is not as complex as it may seem. You'll use these cutting-edge financial products better if you have a proper understanding of them, no doubt about it! Having a Demat and trading account is crucial whether you're trading derivatives or making investments in upcoming IPOs. If you don't already have one, head over to Motilal Oswal right now to open a free Demat account and trading account.

 

Related Articles: How to Open a Demat Account Without a Broker | Factors to Keep in Mind While Opening a Demat account | Factors to Consider When Opening a Demat Account | 10 Points to Remember When Operating your Demat Account | Types Of Demat Account & Trading Account

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