Naked Options
Selling naked call options can be an extremely risky strategy. So, what exactly are they? The term “naked option” refers to options that are sold without having something to back it.
There are two different kinds of naked options, call options and put options. When you sell a naked call you get money up front, but you are also under the obligation to sell the stock at a specific price on or before a specific date.
There is no riskier trade then selliing a call without having something backing it up. There is no limit to the amount that you can lose on a single trade. For instance if you sell the $40 call you will be obligated to sell the stock at $40, so if it goes up to $41 or higher you will have to buy it at that price and sell it at $40.
There isn’t a limit to how far a stock is able to move upward. This means that there is also no limit to how much an investor could potentially lose when selling a call option. That is the reason I don’t like selling naked calls, just too much risk involved.
There is a second type of naked option and it comes with a little less risk. When you sell a put option you still make money up front however you are obligated to buy the stock at a certain price. An example of this would be if you sold the $40 put you would be obligated to buy the stock at $40 whenever you where called out.
This means the most you could lose when selling naked puts is the price of the stock, in this case $40. That is a lot less then infinite risk, but it is still a lot of risk to take.
So, if you are selling options you may want to limit your risk by creating option spread strategy by either buying another option on the stock or the stock itself. For example if you sold the $40 call you could also buy the $45 call. You will have to use some of your profits to buy the 2nd call, but your risk will go from being unlimited to $5, a huge difference.
