Risky investment strategies – Naked calls explained

Naked calls are not recommended unless you are a very experienced investor. The reason for this is that no matter what you do, you are taking an almost unlimited risk with the naked call option. Of course, you do stand the chance to make a lot of money on these calls – but the risk is probably not worth it unless you have money to gamble with.

For most calls, the person who is writing the call actually owns the stock. These are “covered calls”. Essentially, if you write a covered call, then the highest risk is just that you’ll have to sell your stock for the call value instead of its actual price. In this case, you might lose some money, but there is a limit to how much you can lose.

Additionally, the money that you lose in this case is money that you would not necessarily get to begin with – it is possible that the stock would not have sold at the higher price anyway.

However, naked calls are written when the person does not already own the stock. Here’s how it works:

First, you will pick a stock that you think will not perform well during the period of time that you intend to write a call for. This will be stock that you do not already own. Therefore, you are writing a call to sell the stock at a particular price, and you can sell those call options.

Second, you hope that the stock price does not rise above the price that you wrote the call for. In the case of naked calls, you are gambling that they will never be exercised because the stock you want to buy will stay below the call price.

Finally, after the call options expire, you check the prices. If the stock is lower than the call price, the buyer will not have to exercise the call and will just buy the stock at the lower price. However, if the stock has gone above the call price, then you will have to buy the stock at the higher price and sell it to the buyer at the price of the naked call.

Since you do not already own the stock, the amount of money that you could lose in a naked call is unlimited – depending on the number of shares that you will be trading, you could lose thousands of dollars on a single naked call gone wrong.

Therefore, unless you have the money to gamble with, it is recommended that you only write calls on stock that you already own. This way, you will limit your losses.