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. Naked Call

    An options strategy in which an investor writes (sells) call ...
  3. Back Fee

    A payment made to the writer of a compound option in the case ...
  4. Call Option

    An agreement that gives an investor the right (but not the obligation) ...
  5. Naked Option

    A trading position where the seller of an option contract does ...
  6. Call Over

    When the buyer of a call option exercises the option. In options ...
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. 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.
  3. Trading

    Options Pricing

    Options are valued in a variety of different ways. Learn about how options are priced with this tutorial.
  4. Trading

    Naked Options Expose You To Risk

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

    Three Ways to Profit Using Call Options

    A brief overview of how to provide from using call options in your portfolio.
  6. Managing Wealth

    20 Investments: Options (Stocks)

    What Is It? Options are a privilege sold by one party to another that offers the buyer the right to buy (call) or sell (put) a security at an agreed-upon price during a certain period of time ...
  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. Investing

    Options Basics: Conclusion

    Options are sophisticated trading tools that can be dangerous if you don't educate yourself before using them. Please use this tutorial as it was intended - as a starting point to learning more ...
  9. 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.
  10. Trading

    Options Traders

    An options trader is anyone who buys and sells options in the capital market. As options trading is most commonly conducted through online option trading brokers, it is also commonly known as ...
RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. 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 >>
  4. 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 >>
  5. How do you trade put options on E*TRADE?

    Learn all about put option trading at E*TRADE. Explore margin accounts and become familiar with the different types of option ... Read Answer >>
  6. What is the difference between a banker's acceptance and a post-dated check?

    Learn more about speculation, stocks and options and how speculators use these financial instruments in an attempt to profit ... Read Answer >>
Hot Definitions
  1. Glass-Steagall Act

    An act the U.S. Congress passed in 1933 as the Banking Act, which prohibited commercial banks from participating in the investment ...
  2. Quantitative Trading

    Trading strategies based on quantitative analysis which rely on mathematical computations and number crunching to identify ...
  3. Bond Ladder

    A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of ...
  4. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  5. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  6. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
Trading Center