Naked Option
Candlefocus EditorA call option is a contract that gives the holder the right to buy a certain amount of a security at an agreed-upon price, known as the strike price, at or before a set expiration date. A put option gives the holder the right to sell a security at an agreed-upon price at or before a set expiration date.
When a naked call option is exercised, the seller of the option must fulfill the sale of the security at the strike price by taking on a short position in the account. On the other hand, when a naked put option is exercised, the seller of the option must buy the security at the strike price by taking a long position in the account. Both of these transactions created potential losses if the stock's rapid price movements are against the trader's bet before expiration.
Naked options are complex and risky, and typically are suitable only for traders with a high level of risk tolerance and financial sophistication. They carry the threat of large losses and should not be traded without a thorough understanding of the potential risks and rewards. Before entering into a naked options trade, traders should have ample funding in their accounts to cover the potential losses in case the option is exercised.
Naked options require substantial expertise to handle properly. Beginner traders should avoid this trading strategy and stick to more conservative options that require less risk and complexity. Only traders with the experience and the resources should consider entering into naked options trades.