What is a Naked Writer
A naked writer is the seller of an options contract who does not own the underlying security (for a call option), or does not short the underlying security (for a put option). In other words, the option writer is unhedged. Such options are known as naked options or uncovered options.
BREAKING DOWN Naked Writer
Naked writers try to profit by receiving premiums for writing and selling options contracts without the need to hedge themselves against adverse movements of the underlying security’s price. Brokers typically have specific rules regarding naked options trading, and inexperienced traders may not be allowed to place this type of order.
Naked Call Strategy
A trader who writes a naked call, by selling call options on the open market without owning the underlying security exposes themselves to potentially unlimited losses, as there is theoretically no limit to how high a stock can rise. This is because they have accepted the obligation to sell the underlying stock at the strike price at or before expiration, no matter how high the share price rises. If the options contract is exercised, the naked writer will be forced to buy a number of shares at a potentially undesirable price to meet their contractual obligation. In contrast, in a covered call strategy, the trader owns the underlying security on which the call options are written. For more on naked call writing, read Naked Call Writing: A High Risk Options Strategy.
Naked Put Strategy
A trader who writes a naked put, does not hold the underlying position, which is a short position in the underlying security to cover the contract in case the option is exercised. Because the naked writer has accepted the obligation to buy the underlying asset at the strike price if the option is exercised at or before its expiration date, they will lose money if the security’s price falls. While the risk is contained, because the underlying asset can only drop to zero dollars, it can still be large. In contrast, in a covered put, the trader will maintain a short position in the underlying security.