By Investopedia Updated Jan 4, Selling naked calls creates unlimited liability.
Therefore, these types of option strategies are considered appropriate for sophisticated traders with proper risk management and discipline due to the limitless losses. Selling calls is typically done against existing stock holdings in an attempt to create income from the position by capturing premium.
For example, assume that a trader owns 1, shares of Options positions Inc.
If Apple does not climb options positions that level by the option's expiration date, he can hold onto his shares and pocket the premium. Owning the shares takes the risk away from this strategy.
In the case of naked selling of call options, the risk is theoretically unlimited. This example illustrates the dangers of naked selling call options.
How and When to Defend Naked Options Positions - Best Practices
Naked selling of put options can be quite dangerous in the event of a steep fall in the price of a stock. The option seller is forced to buy the stock at a certain price.
However, the lowest the stock can drop to is zero, so there is a floor to the losses. In the case of call options, there is no limit to how high a stock can climb, meaning that potential losses are limitless.