Naked call

A naked call occurs when a speculator writes (sells) a call option on a security without ownership of that security. It is one of the riskiest options strategies because it carries unlimited risk as opposed to a naked put where the maximum loss occurs if the stock falls to zero. A naked call is the opposite of a covered call.[1]

The buyer of a call option has the right to buy a specific number of shares at a strike price before an expiration date from the call option seller. Since a naked call seller does not have the stock in case the option buyer decides to exercise his option, he has to buy stock at the open market in order to deliver it at the strike price. Since the share price has no limits to how far it can rise, the naked call seller is exposed to unlimited risk.

Contents

Examples

Stock XYZ is trading at $47.89 per share DEC 50 Call is trading at $1.25 premium

Investor A forecasts that XYZ will not trade above $50 per share before December, so he sells the 10 DEC 50 Calls for $1,250 (each option contract controls 100 shares). Investor A doesn't buy the stock, therefore his investment is considered naked.

Meanwhile, Investor B forecasts that XYZ will go above $50, so he purchases those 10 calls from Investor A for $1,250. At expiration of the option, consider 4 different scenarios where the share price drops, stays the same, rises moderately or surges.

The following are four scenarios for the example:

Scenario 1

Stock drops to $43.25 DEC 50 Call expires worthless

Investor A keeps the entire premium of $1,250 Investor B makes a 100% loss

Scenario 2

Stock stays at $47.89 DEC 50 Call expires worthless

Investor A keeps the entire premium of $1,250 Investor B makes a 100% loss

Scenario 3

Stock rises to $52.45 DEC 50 Call is exercised

Investor A is forced to buy 1,000 shares of XYZ for $52,450 and immediately sell them at $50,000 for a loss of $2,450. Since he received the premium of $1,250 before, his net loss is $1,200. Investor B buys 1,000 shares of XYZ for $50,000 and now is able to sell them at open market for $52.45 per share if he chooses to. His net gain is $1,200 (same as Investor A's loss excluding commission costs)

Scenario 4

Stock surges to $75.00 on a news announcement DEC 50 Call is exercised

Investor A is forced to buy 1,000 shares of XYZ for $75,000 and immediately sell them at $50,000 for a loss of $25,000. Since he received the premium of $1,250 before, his net loss is $23,750 Investor B buys 1,000 shares of XYZ for $50,000 and now is able to sell them at open market for $75.00 per share if he chooses to. His net gain is $23,750 (same as Investor A's loss excluding commission costs)

References


Wikimedia Foundation. 2010.

Look at other dictionaries:

  • Naked Call — An options strategy in which an investor writes (sells) call options on the open market without owning the underlying security. This stands in contrast to a covered call strategy, where the investor owns the security shares that are eligible to… …   Investment dictionary

  • naked call —  An option to buy a stock that is not actually owned by the seller of the option.  ► “Some employ an array of strategies such as buying on credit, writing naked call options and using other forms of LEVERAGE.” (Wall Street Journal, March 14, 1996 …   American business jargon

  • naked call writing — Selling (writing) a call option on equities that one does not own. A person may do this if he or she expects the price of a particular share to fall or remain unchanged. It is, however, a dangerous strategy because if the price rises the shares… …   Big dictionary of business and management

  • Call option — This article is about financial options. For call options in general, see Option (law). A call option, often simply labeled a call , is a financial contract between two parties, the buyer and the seller of this type of option.[1] The buyer of the …   Wikipedia

  • naked — When an option writer writes a call or put without owning the underlying asset. The CENTER ONLINE Futures Glossary The position of an option holder who does not also own an offsetting position in the underlying. For example, an investor who sells …   Financial and business terms

  • Naked Women's Wrestling League — Acronym NWWL Founded 2004 Defunct sometime in 2009 Owner(s) Howard Mann …   Wikipedia

  • Naked to the World — Studio album by Teena Marie Released March 12, 1988 Recorded 1987 …   Wikipedia

  • Naked Idol (TV movie) — Naked Idol The Naked Brothers Band episode Episode no. Season 3 Episode 8 9 Directed by Polly Draper Written by …   Wikipedia

  • Naked Came the Manatee —   …   Wikipedia

  • Naked Truth (Sarah-Hudson-Album) — Naked Truth Studioalbum von Sarah Hudson Veröffentlichung 7. September 2005 Label EMI Records/S Curve Format …   Deutsch Wikipedia


Share the article and excerpts

Direct link
Do a right-click on the link above
and select “Copy Link”

We are using cookies for the best presentation of our site. Continuing to use this site, you agree with this.