Uncovered option. uncovered option
Also found in: DictionaryThesaurus. Naked Option An option contract without another, opposite option hedging the risk.
Unlike more complex spreads and straddleswhich involve uncovered option purchase or sale of multiple options in order to profit in different ways, naked options are straightforward calls or puts. An investor with a naked option makes a profit or uncovered option depending on the movement of the underlying asset. Naked options uncovered option also called uncovered options.
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See also: Covered options. Farlex Financial Dictionary.
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Uncovered option. An uncovered option, also known as a naked option, is an option that is not backed by another position.
For example, if you sell a call option without owning the stock that you would have to legal internet earnings if the option holder exercised, the call is uncovered.
Similarly, if you sell an uncovered put, you don't have adequate cash uncovered option reserve to fulfill your obligation to purchase the underlying instrument at exercise. Writing uncovered contracts can put you at significant risk despite the premium you collect when you open the position.
The forecast must predict that the stock price will not rise above the break-even point before expiration. Strategy discussion Selling an uncovered call based on a neutral-to-bearish forecast requires both a high tolerance for risk and trading discipline. A high tolerance for risk is required, because risk is theoretically unlimited. In practice, a sharp price rise can cause very large losses, losses that could exceed account equity. A takeover bid or an unexpected uncovered option of good news might cause the underlying stock to gap up in price, which could result in such a loss.
For example, if a naked call option were exercised and assigned to you, you would have to buy the underlying instrument at its market price to be able to meet the terms of the contract. Because of the potential risk, your brokerage firm may restrict your right to write uncovered positions uncovered option may require you to trade these options in a margin account.
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