Uncovered Option

What is an 'Uncovered Option'

An uncovered option is a type of options contract that is not backed by an offsetting position that would help mitigate risk. "Trading naked", as it is called, poses significant risks. However, an uncovered options contract can be profitable for the writer if the buyer cannot exercise the option because it is out of the money.

Generally, uncovered options are suitable only for experienced, knowledgeable investors who understand the risks and can afford substantial losses.

Also called a "naked option".

BREAKING DOWN 'Uncovered Option'

If a market participant sells a call option without owning the underlying instrument, the call is uncovered. If the buyer exercises his or her right to purchase to underlying instrument, the person who sold the call option (the writer) will need to buy the underlying instrument at its current market price in order to fulfill the contract.

Because of the inherent risks in trading uncovered options, many brokers restrict account holders from writing uncovered option positions, thereby limiting clients' exposure to unlimited market risk.

RELATED TERMS
  1. Naked Writer

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

    The seller of an option who collects the premium payment from ...
  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. Writing An Option

    The expression "writing an option" refers to the act of selling ...
  6. Naked Put

    A put option whose writer does not have a short position in the ...
Related Articles
  1. Trading

    Options Hazards That Can Bruise Your Portfolio

    Learn the top three risks and how they can affect you on either side of an options trade.
  2. 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.
  3. Markets

    How to Trade Options on Government Bonds

    A look at trading options on debt instruments, like U.S. Treasury bonds and other government securities.
  4. Trading

    Three Ways to Profit Using Call Options

    A brief overview of how to provide from using call options in your portfolio.
  5. Trading

    Naked Call Writing: A Risky Options Strategy

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

    Types of Options

    There are many different types of options. In addition to general put options and call option, we will discuss 13 different types of options. Some of these option types are better suited to day ...
  7. 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.
  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

    Cut Down Option Risk With Covered Calls

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

    Exploring The World Of Exotic Options

    Exotic options provide investors with new alternatives to manage their portfolio risks and speculate on various market opportunities. The pricing for such instruments is considerably complex, ...
RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. How can derivatives be used to earn income?

    Learn how option selling strategies can be used to collect premium amounts as income, and understand how selling covered ... Read Answer >>
  4. What is the difference between open interest and volume?

    Learn more about options, what options' volume and open interest are and the difference between volume and open interest ... Read Answer >>
  5. Do options make more sense during bull or bear markets?

    Understand how options may be used in both bullish and bearish markets, and learn the basics of options pricing and certain ... Read Answer >>
  6. 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 >>
Hot Definitions
  1. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  2. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  3. Diversification

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

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

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  6. 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 ...
Trading Center