Why Call and Put Options are Considered Risky

As with most investment vehicles, risk to some degree is inevitable. Option contracts are notoriously risky due to their complex nature, but knowing how options work can reduce the risk somewhat. There are two types of option contracts, call options and put options, each with essentially the same degree of risk. Depending on which "side" of the contract the investor is on, risk can range from a small prepaid amount of the premium to unlimited losses. Thus, knowing how each works helps determine the risk of an option position. In order of increasing risk, take a look at how each investor is exposed.

Long Call Option

Investor A purchases a call on a stock, giving them the right to buy it at the strike price before the expiry date. They only risk losing the premium they paid if the option was never exercised.

Covered Call

Investor B, who wrote a covered call to Investor A, takes on the risk of being "called out" of their long position in the stock, potentially losing out on upside gains.

Covered Put

Investor A purchases a put on a stock they currently have a long position in. Potentially, they could lose the premium they paid to purchase the put if the option expires. They could also lose out on upside gains if they exercise and sell the stock.

Cash-Secured Put

Investor B, who wrote a cash-secured put to Investor A, risks the loss of their premium collected if Investor A exercises and risks the full cash deposit if the stock is "put to them."

Naked Put

Suppose Investor B instead sold Investor A a naked put. Then, they might have to buy the stock, if assigned, at a price much higher than market value.

Naked Call

Suppose Investor B sold Investor A a call option without an existing long position. This is the riskiest position for Investor B because if assigned, they must purchase the stock at market price to make delivery on the call. Since market price, theoretically, is infinite in the upward direction, Investor B's risk is unlimited.