What is a 'Naked Option'

A naked option is a trading position where the seller of an option contract does not own any, or enough, of the underlying security to act as protection against adverse price movements. If the price of the underlying security moves against the trader, who does not already own the underlying security, he or she would be required to purchase the shares regardless of how high the price is. The potential for losses, then, can be unlimited, and as a result, brokers typically have specific rules regarding naked trading. Inexperienced traders, for example, would not be allowed to place this type of order.

BREAKING DOWN 'Naked Option'

Naked trading is considered very risky since losses can be significant. An options trader could sell, for example, call options with a strike price of $10. If the stock's price rises to $20 or $30 on good news, and the option is naked (the seller does not own the underlying stock). He or she would be required to buy the specified number of shares at the current price, and sell them to the option buyer for the $10, resulting in a significant loss.

Want to know more? Read Naked Options Expose You To Risk

RELATED TERMS
  1. Naked Writer

    An options seller who does not own the underlying security for ...
  2. Naked Position

    A securities position that is not hedged from market risk. Both ...
  3. Naked Call

    An options strategy in which an investor writes (sells) call ...
  4. Naked Shorting

    The illegal practice of short selling shares that have not been ...
  5. Sell To Open

    A phrase used by many brokerages to represent the opening of ...
  6. Short Call

    A type of strategy regarding a call option, which is a contract ...
Related Articles
  1. Trading

    Naked Options Expose You To Risk

    Find out why these enticing options can spell trouble for your bottom line.
  2. Trading

    Naked Call Writing: A Risky Options Strategy

    Learn about this aggressive trading strategy to generate income as part of a diversified portfolio.
  3. Trading

    Explaining The Naked Call

    A naked call is one of the riskier options strategies around. Find out how this strategy works, as well as the potential risks and rewards of using it.
  4. Investing

    The Truth About Naked Short Selling

    The media demonizes naked short selling, but in most cases it occurs in a collapse, rather than causing it.
  5. Trading

    Should Your Options Go Naked?

    Compare naked strategies to credit spreads and see if the unlimited risk of going naked is worth it.
  6. Trading

    A Guide Of Option Trading Strategies For Beginners

    Options offer alternative strategies for investors to profit from trading underlying securities, provided the beginner understands the pros and cons.
  7. Trading

    Collecting Option Premium In The Grain Market

    Believe it or not, there are some great income-generating strategies that are lower in risk.
  8. Investing

    The Risks Of Writing Covered Calls

    While writing a covered call option is less risky than writing a naked call option, the strategy is not entirely riskfree.
  9. Trading

    Cut Down Option Risk With Covered Calls

    A good place to start with options is writing these contracts against shares you already own.
RELATED FAQS
  1. My brokerage firm won't allow naked option positions. What does this mean?

    A naked position refers to a situation in which a trader sells an option contract without holding a position in the underlying ... Read Answer >>
  2. What types of options positions create unlimited liability?

    Understand that naked selling of call options can create unlimited amounts of liability and potentially lead to devastating ... Read Answer >>
  3. How is a short call used in a naked call writing option strategy?

    Learn how a short call is used in a naked call writing strategy, and understand the high degree of risk associated with this ... Read Answer >>
  4. What is the difference between a covered call and a regular call?

    Learn what a call option is, what two strategies call options can be used for, and the difference between a covered call ... Read Answer >>
  5. Are put options more difficult to trade than call options?

    Learn about the difficulty of trading both call and put options. Explore how put options earn profits with underlying assets ... Read Answer >>
  6. Are there any risks involved in trading put options through a traditional broker?

    Explore put option trading and different put option strategies. Learn the difference between traditional, online and direct ... Read Answer >>
Hot Definitions
  1. Federal Direct Loan Program

    A program that provides low-interest loans to postsecondary students and their parents. The William D. Ford Federal Direct ...
  2. Cash Flow

    The net amount of cash and cash-equivalents moving into and out of a business. Positive cash flow indicates that a company's ...
  3. PLUS Loan

    A low-cost student loan offered to parents of students currently enrolled in post-secondary education. With a PLUS Loan, ...
  4. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  5. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  6. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
Trading Center