Naked Option

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. Writing An Option

    The expression "writing an option" refers to the act of selling ...
  6. Uncovered Option

    A type of options contract that is not backed by an offsetting ...
Related Articles
  1. Trading

    Naked Call Writing: A Risky Options Strategy

    Learn about this aggressive trading strategy to generate income as part of a diversified portfolio.
  2. 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.
  3. Trading

    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.
  4. 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.
  5. Markets

    Collecting Option Premium In The Grain Market

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

    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.
  7. Trading

    Cut Down Option Risk With Covered Calls

    A good place to start with options is writing these contracts against shares you already own.
  8. Trading

    Introduction - Day Trading and Options

    Options have not been a tradition part of day-trading strategy, but this is quickly changing.
  9. Trading

    The Basics of Options Profitability

    The adage "know thyself"--and thy risk tolerance, thy underlying, and thy markets--applies to options trading if you want it to do it profitably.
  10. Trading

    Stock Options: What's Price Got To Do With It?

    A thorough understanding of risk is essential in options trading. So is knowing the factors that affect option price.
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. 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 >>
  5. 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 >>
  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. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  2. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
  3. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  4. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  5. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  6. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
Trading Center