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- Updated On:03-Mar-2021
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Naked or Uncovered Option trading is a type of trading/speculating where a Call or Put option is bought or sold by different individuals at the same time expecting different price direction movements. Naked Option trading is a Zero-Sum game which means that the Profit for one is a Loss for the other individual.

Naked or Uncovered options trading is a way of speculating in the derivatives space where a trader or investor buys or writes (Sells) an option in order to benefit from the price change of the Option Price.

Trading naked options are **pure speculating activity** as it does not involve any hedge against the position taken by the trader. In an uncovered option trade (Buying or Selling) there is an **obligation to take or give delivery of the underlying asset** (stock) on the date of expiry.

If a seller of a Call option holds on to his position till the date of expiry then he is obligated to give the delivery of the underlying asset to the Option buyer. In this same way, the Buyer of a Call option will have to pay the entire amount of the underlying security and take delivery of the Security.

There are 2 aspects of Naked or Uncovered Option Strategies, they are-

**1. Option Buying**

**2. Option Writing**(Selling)

In Option buying the trader **buys** an Option by paying a small price for it known as the **Premium** expecting the price of the underlying asset to rise or fall to that specific **Strike Price** before the expiry in order to earn money. Option buying can be compared to buying a lottery ticket as the chances of winning big is there but are very small. For example, the buyer of a **call Option** will start to make money when the price of the Underlying Stock/Index will go above his Strike Price before the expiry.

The chances of making money in Option Buying are quite less as Option Greeks such as Delta, Gama (Option Decay) are against Option buyers. The advantage in option buying is that the loss is limited to the Total Premium paid while purchasing the option and the maximum profit is limitless.

Opting writing or **Option selling** is comparatively more profitable than Option Buying as the Option Greeks work in favor of the option writer to reduce the price of the option. Option Selling is also treated as a steady business because the Return On Investment (ROI) is reasonable and if done right can provide steady profits for option writers. In Option Selling the Seller sells an Option and **Collects the Premium** at the time of execution and buys it at a lower price at a later time to earn Profit.

**Let's see how Naked Options Trading works-**

In a Naked Call option strategy, the Buyer of the Call option Buys the Option by paying a premium of **'X'** amount, and the same **'X'** amount is collected by the Writer (seller) of that particular Option. Now if the price of the Underlying security rises then the Premium of the Call Option will rise hence the Buyer of that Option will make money and simultaneously the Seller will face some MTM (Mark To Market) losses till the time he holds on to the position.

A naked Put Option is bought by the Option buyer anticipating that the price of the underlying security will fall and the Seller of the Put option sells that same Put option anticipating that the price of the particular asset will rise. Now if the Price of the underlying security starts to rise then the Price of the Put Option will fall resulting in a loss for the option buyer and an MTM profit for the Option seller.

In the following ways, **Naked Options** are bought and sold in order to earn money from the price movement of the underlying asset. Buying Naked options is extremely risky as the value of the option becomes worthless on the day of expiry if the price is away from the particular Strike Price.

On the other hand, Option sellers face the risk of unlimited losses, but the chances of making profits consistently in Option writing is more than Option Buying. Trading in Naked or Uncovered Option is very risky hence it is always a good idea to hedge the Naked positions to minimize the losses and maximize the gains.

Tagged With: uncovered options tradingnaked options tradingcall optionput option

Categories: Option Trading

Still got Doubts?

Related FAQs

How much money do I need to begin Options Selling?My friend said option selling is profitable but how much money is required?

Option Selling requires large capital. Due to this many small retail traders resort to option buying where the margin money required is very less. Although with various strategies you can reduce your overall risk and margin required in Options selling. Know more about how much money is required to start option selling. The difference in the margin money required for selling a naked Option vs Selling a Hedged Option here.

What is the Best strategy for Options Trading?

There are many complex Option Trading strategies out there but the most profitable are some of the simpler ones. The top 3 of them are Long & Short Straddles, Long & Short Strangles and Bull/Bear spreads.

As a beginner, Which is better platform Sensibull or Opstra for Option Traders? I want to start option trading but have no idea which is best?

If you're looking for a straightforward and comprehensive take on options trading, then Sensibull should do the job perfectly. However, if you're and expert and want more complex trading tools, then Opstra is the one to choose.

Which is the simplest options strategy for beginners?

Options trading can be done in diverse ways. You can trade Options in unhedged or Naked positions as well as use multi-leg strategies to limit the losses. An endless combination of options can be used to put together a strategy. This can get complex sometimes. But many simple Option strategies can be used by Beginners. More of such strategies are discussed here.

What is Open Interest in Options Trading in Stock markets? Examples

Open Interest is a parameter used by technical analysts and options traders to judge the mood of the market. Open Interest is the total number of outstanding option contracts in a particular strike price of an underlying asset. The OI is an important factor as it defines liquidity and the total number of contracts that are traded at a particular point in time.

Can I trade in US options from India? Is there a way to buy and sell US options from India without any efforts?

Yes, individuals can trade US options from India. There are many platforms as well which allows the individuals to trade internationally, it just depends on them what they are comfortable the most with and prefer trading from.

What is the minimum amount required for Options Trading in India?

Options are of two types- call option and put option. You need quite an amount of money to trade in options because it has costs such as premium, brokerage. etc. To know more about the topic, read the detailed version.

Why is Options Trading considered risky?

Options trading is different from traditional share trading in many ways. Trading in options includes multiple factors like high leverage, delivery obligation on the date of expiry, unlimited loss potential, etc. All these factors make trading in options riskier.

Which is a better platform Sensibull or Opstra for Options trading?

In this current day and age, options trading has become the new cool thing that everyone wants to try. There are many option trading platforms out there that provide various Option trading tools. Sensibull and Opstra Definege are 2 of the most prominent names in the industry.

Both of them provide all the necessary tools like OI (Open Interest) Charts, PCR (Put-call Ratio), IV (Implied Volatility) chart, etc. But the main question lies, which one of them is a better platform for Options trading. Let's find the answer to that question.

What will happen if I don’t square off my option contract on Trading Day? Explain its consequences on each side of trade.

If you forget to square off your option contract at the end of the day, the contract will automatically be settled if it's an in-the-money option. The contract would be settled on the expiry date and will be sold at the market price.