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.

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.

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)

Naked call Topic - Options

In finance, an option is a contract between a buyer and a seller that gives the buyer the right, but not the obligation, to buy or to sell a particular asset (the underlying asset) on or before the option's expiration time, at an agreed price, the strike price. In return for granting the option, the seller collects a payment (the premium) from the buyer. A call option gives the buyer the right to buy the underlying asset and a put option gives the buyer of the option the right to sell the underlying asset. If the buyer chooses to exercise this right, the seller is obliged to sell or buy the asset at the agreed price. The buyer may choose not to exercise the right and let it expire. The underlying asset can be a piece of property, a security (stock or bond), or a derivative instrument, such as a futures contract.