Naked Option

AAA

DEFINITION of 'Naked Option'

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. Call

    1. The period of time between the opening and closing of some ...
  2. Naked Shorting

    The illegal practice of short selling shares that have not been ...
  3. Naked Call

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

    A financial derivative that represents a contract sold by one ...
  5. Naked Position

    A securities position that is not hedged from market risk. Both ...
  6. Underlying

    1. In derivatives, the security that must be delivered when a ...
Related Articles
  1. Options & Futures

    Naked Options Expose You To Risk

    Find out why these enticing options can spell trouble for your bottom line.
  2. Options & Futures

    Naked Call Writing: A Risky Options Strategy

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

    Options Basics Tutorial

    Discover the world of options, from primary concepts to how options work and why you might use them.
  4. Options & Futures

    Should Your Options Go Naked?

    Compare naked strategies to credit spreads and see if the unlimited risk of going naked is worth it.
  5. Options & Futures

    Use Options to Hedge Against Iron Ore Downslide

    Using iron ore options is a way to take advantage of a current downslide in iron ore prices, whether for producers or traders.
  6. Home & Auto

    Understanding Rent-to-Own Contracts

    They can work for you or against you. Here's how to negotiate a fair one.
  7. Options & Futures

    Understanding How Dividends Affect Option Prices

    Learn how the distribution of dividends on stocks impacts the price of call and put options, and understand how the ex-dividend date affects options.
  8. Home & Auto

    Avoiding the 5 Most Common Rent-to-Own Mistakes

    Pitfalls that a prospective tenant-buyer could encounter on the road to purchase – and how not to stumble into them.
  9. Home & Auto

    Renting vs. Owning: Which is Better for You?

    Despite the conventional wisdom, renting might make more financial sense than you think.
  10. Investing Basics

    Explaining Options Contracts

    Options contracts grant the owner the right to buy or sell shares of a security in the future at a given price.
RELATED FAQS
  1. How can derivatives be used to earn income?

    One strategy for earning income with derivatives is selling options to collect premium amounts. Often, options expire worthless, ... Read Full Answer >>
  2. Do options make more sense during bull or bear markets?

    Options and various option strategies can be used in bull and bear markets. Certain option strategies can be used to profit ... Read Full Answer >>
  3. How do you trade put options on Ameritrade?

    To trade put options with TD Ameritrade, you need a margin account funded with more than $2,000 that is authorized to trade ... Read Full Answer >>
  4. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
  5. What are common delta hedging strategies?

    The term delta refers to the change in price of an underlying stock or exchange-traded fund (ETF) as compared to the corresponding ... Read Full Answer >>
  6. How do I determine the breakeven point for a short put?

    The breakeven point for a short put is the strike price of the option minus the premium. Selling puts is a way for traders ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Bubble Theory

    A school of thought that believes that the prices of assets can temporarily rise far above their true values and that these ...
  2. Stock Market Crash

    A rapid and often unanticipated drop in stock prices. A stock market crash can be the result of major catastrophic events, ...
  3. Financial Crisis

    A situation in which the value of financial institutions or assets drops rapidly. A financial crisis is often associated ...
  4. Election Period

    The period of time during which an investor who owns an extendable or retractable bond must indicate to the issuer whether ...
  5. Shanghai Stock Exchange

    The largest stock exchange in mainland China, the Shanghai Stock Exchange is a nonprofit organization run by the China Securities ...
  6. Dead Cat Bounce

    A temporary recovery from a prolonged decline or bear market, followed by the continuation of the downtrend. A dead cat bounce ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!