Naked call
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A Naked Call occurs when a speculator writes (sells) a call option on a security without ownership of that security. It is one of the riskiest options strategies because it carries unlimited risk as opposed to a naked put where the maximum loss occurs if the stock falls to zero.
The buyer of a call option has the right to buy a specific number of shares at a strike price before an expiration date from the call option seller. Since a naked call seller does not have the stock in case the option buyer decides to exercise his option, he has to buy stock at the open market in order to deliver it at the strike price. Since the share price has no limits to how far it can rise, the naked call seller is exposed to unlimited risk.
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[edit] Examples
Stock XYZ is trading at $47.89 per share DEC 50 Call is trading at $1.25 premium
Investor A forecasts that XYZ will not trade above $50 per share before December, so he sells the 10 DEC 50 Calls for $1,250 (each option contract controls 100 shares). Investor A doesn't buy the stock, therefore his investment is considered naked.
Meanwhile, Investor B forecasts that XYZ will go above $50, so he purchases those 10 calls from Investor A for $1,250. At expiration of the option, consider 4 different scenarios where the share price drops, stays the same, rises moderately or surges.
The following are four scenarios for the example:
[edit] Scenario 1
Stock drops to $43.25 DEC 50 Call expires worthless
Investor A keeps the entire premium of $1,250 Investor B makes a 100% loss
[edit] Scenario 2
Stock stays at $47.89 DEC 50 Call expires worthless
Investor A keeps the entire premium of $1,250 Investor B makes a 100% loss
[edit] Scenario 3
Stock rises to $52.45 DEC 50 Call is exercised
Investor A is forced to buy 1,000 shares of XYZ for $52,450 and immediately sell them at $50,000 for a loss of $2,450. Since he received the premium of $1,250 before, his net loss is $1,200. Investor B buys 1,000 shares of XYZ for $50,000 and now is able to sell them at open market for $52.45 per share if he chooses to. His net gain is $1,200 (exact same as Investor A lost excluding commission costs)
[edit] Scenario 4
Stock surges to $75.00 on a news announcement DEC 50 Call is exercised
Investor A is forced to buy 1,000 shares of XYZ for $75,000 and immediately sell them at $50,000 for a loss of $25,000. Since he received the premium of $1,250 before, his net loss is $23,750 Investor B buys 1,000 shares of XYZ for $50,000 and now is able to sell them at open market for $75.00 per share if he chooses to. His net gain is $23,750 (exact same as Investor A lost excluding commission costs)
Although the naked call seller may profit from stocks that do not change in price or even rise slightly against him, the investor is exposed to unlimited risk. Also, note that this option strategy requires a Level 5 trading level with brokerages, and is usually granted only to experienced traders.
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