Naked call

A naked call occurs when a speculator writes (sells) a call option on a security without holding ownership of said security. A naked call is the opposite off a naked put. A naked call is considered an extremely high-risk strategy that may be utilised by a speculator with little money for trading and no concern for potentially unlimited losses.

Example

Share XYZ is currently selling at $85 per share and Speculator A decides to sell the right to own 50 shares of XYZ (call option) at a strike price of $100 dollars per share on or before May 10th for $24.

Speculator B buys the call option for $24 and now holds the right to buy 50 shares of XYZ for $100 at any time on or before May 10th at which time the call option will expire.

If the XYZ shares fail to rise above $100 before May 10th, the call option expires worthless and Speculator A makes a profit of $24.

However, if the XYZ shares rise above $100 before May 10th, Speculator B may force Speculator A to buy 50 shares of XYZ at market price and sell them back to Speculator B for $100 each. In this scenario, the Speculator A makes a loss of (50 * XYZ market price) - (50 * $100) - $24. As market price can rise an unlimited amount, Speculator A can experience unlimited losses in this ‘worst case’ scenario. Conversely, Speculator B now owns 50 shares of XYZ for a bargain price of $100 which they can immediately sell back to the market for a profit equal to Speculator A’s loss.[1]


References
  1. Juggernaut (2012-07-12). "When to Use A Naked Call Option". Archived from the original on 2013-07-10.
This article is issued from Wikipedia. The text is licensed under Creative Commons - Attribution - Sharealike. Additional terms may apply for the media files.