Naked options can come with such a huge loss potential and should be considered extremely risky. What are naked options? The term “naked option” refers to options that are sold without having something to back it.
There are two different kinds of naked options, call options and put options. When you sell a naked call you get money up front, but you are also under the obligation to sell the stock at a specific price on or before a specific date.
There is no riskier trade then selliing a call without having something backing it up. The amount that you could possibly lose is unlimited. For instance if you sell the $40 call you will be obligated to sell the stock at $40, so if it goes up to $41 or higher you will have to buy it at that price and sell it at $40.
Because there is no limit to how high a stock can go there is no limit to how much you can lose on a single trade. For that reason I do not sell naked calls, it simply has too much risk involved with it.
There is a second type of naked option and it comes with a little less risk. When you sell a put option you still make money up front however you are obligated to buy the stock at a certain price. An example of this would be if you sold the $40 put you would be obligated to buy the stock at $40 whenever you where called out.
That means there is a limit, the most you can lose when selling naked put options would be the strike price of the option, in this case $40. This makes it a little bit less risky, but it still comes with a huge loss potential.
This is why it is still better to limit your risk by getting into a spread options by either buying another option on the stock or the stock itself. For example if you sold the $40 call you could also buy the $45 call. You will have to use some of your profits to buy the 2nd call, but your risk will go from being unlimited to $5, a huge difference.
