Naked Call Options
Function: Speculation
Outlook: Bearish
When someone writes (sells) call options against stock that they do not own, the calls are called "naked calls." They are naked because they expose the seller to unlimited losses. If someone owns calls on a stock and sells an equal or lesser number of calls against the same stock, they calls sold are not considered naked because the calls he owns are server as collateral.
Since writing naked calls expose the writer to virtually unlimited losses, most brokers usually require that the writer have a minimum cash balance in his account, usually $100,000 or more.
Example: Advance Micro Devices (AMD) trades for $15, and you think it will go down in price within the next month. You sell ten one-month call contracts with a strike price of $16 for $.95, netting you $950.00 (10 contacts x 100 shares per contract x $.95 per share). If the stock closes anywhere below $16 on the day of expiration, you get to keep the full $950. If it closes anywhere above $16, you are obligated to buy 1,000 shares (10 x 100) at the market price and sell them for $16. Thus, if the stock goes to $21, you will lose $4,150 ($21,000 - $16,000 + $950). You could also simply buy the calls back at a price of $5 per share ($21 - $16), which will still result in a net loss of $4,150.
Naked Call Payoff Graph:
