Naked Call

A naked call occurs when a speculator writes (sells) a call option on a security without holding ownership of said security. A naked call is the opposite of a naked put.

Example

Share XYZ is currently selling at $85 per share and Speculator A decides to sell the right to own 50 shares of XYZ (call option) at a strike price of $100 dollars per share on or before May 10th for $24.

Speculator B buys the call option for $24 and now holds the right to buy 50 shares of XYZ for $100 at any time on or before May 10th at which time the call option will expire.

If the XYZ shares fail to rise above $100 before May 10th, the call option expires worthless and Speculator A makes a profit of $24.

However, if the XYZ shares rise above $100 before May 10th, Speculator B may force Speculator A to buy 50 shares of XYZ at market price and sell them back to Speculator B for $100 each. In this scenario, the Speculator A makes a loss of (50 * XYZ market price) - (50 * $100) - $24. As market price can rise an unlimited amount, Speculator A can experience unlimited losses in this ‘worst case’ scenario. Conversely, Speculator B now owns 50 shares of XYZ for a bargain price of $100 which they can immediately sell back to the market for a profit equal to Speculator A’s loss.^{[1] [2]}

References

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