Welcome to professorsavings.com, we teach finance basics. Today we will be explaining the naked call.
Hi I’m Rayfil Wong. We hope these investment concepts will help you be a better investor.
A naked call is an option strategy where the investor writes call options on a security he doesn’t own, selling these options in the market.
Professor Savings thinks Ali’s Laptop will remain at $55 or even fall. He doesn’t own any shares but he can write a call option for 100 shares of the stock with a strike price of $60. He collects the premium of $500, the $5 price difference on 100 shares.
If Al’s doesn’t rise, Professor Savings keeps the $500 as profit and that option is never exercised. If the stock does rise, however, Professor Savings loses grow in proportion to that rise.
Al’s has a blockbuster quarter and the share price shoots up to $65.
The investor who bought Professor Savings’ option exercises it and Professor Savings has to buy 100 shares at $65 or $6500 and sell them to the investor at $55 each or $5500.
Professor Savings received $500 for the option but lost $1000 when the option contract was exercised. In total, Professor Savings lost $500 on the transaction.
Naked options are considered risky because if their limited upside and potentially unlimited downside.