Uncovered Option
In option trading, the term "uncovered" refers to an option that does not have an offsetting position in the underlying asset. Uncovered option positions are always written options, or in other words options where the initiating action is a sell order. This is also known as selling a naked option.
Definition: In options trading, a 'naked put' refers to selling an options contract without holding the underlying asset. This means the seller has no hedge against their risk and is fully exposed to market fluctuations. Naked puts are typically sold put options, hence also known as 'selling naked puts.'
Origin: The concept of naked puts emerged with the development of the options market. While options trading dates back to the 17th-century Dutch tulip mania, the modern options market took shape after the Chicago Board Options Exchange (CBOE) was established in 1973. Naked puts, as a high-risk, high-reward strategy, gradually gained traction among investors.
Categories and Characteristics:
- Selling Put Options: The seller sells put options without holding the underlying asset, expecting the asset's price will not fall below the option's strike price.
- Selling Call Options: Although less common, some investors sell call options without holding the underlying asset, expecting the asset's price will not rise above the option's strike price.
The main characteristic of naked puts is high risk and high reward. Without a hedge, the seller faces unlimited potential losses but can earn the option premium as profit.
Specific Cases:
- Case 1: Suppose Investor A believes a stock (currently priced at $50) will not fall below $45 in the next month. A sells a put option with a $45 strike price, earning a $2 premium. If the stock price remains above $45 after a month, A keeps the $2 premium as profit.
- Case 2: Investor B sells a call option with a $60 strike price, believing the stock price will not exceed $60. If the stock price is below $60 at expiration, B keeps the premium as profit. However, if the stock price rises significantly, B faces substantial potential losses.
Common Questions:
- Q: What is the main risk of naked puts?
A: The main risk is unlimited potential losses due to the lack of a hedge against the underlying asset's price movements. - Q: Are naked puts suitable for all investors?
A: No, due to the extremely high risk, naked puts are typically only suitable for experienced investors with a high risk tolerance.
