# Naked Call Options Strategy: Risks, Benefits, and How It Works

![Naked Call: An options strategy in which the investor writes (sells) call options without owning the underlying security. ](https://www.investopedia.com/thmb/2gB4xv2_nieFb7-KEKLpkM7yss0=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/nakedcall.asp-final-9ac57ba3d77a4e82a9003ee3a12b5f50.png)

*— Investopedia / Tara Anand*

> **Definition**
>
> A naked call is an options strategy in which an investor writes (sells) call options without owning the underlying security.

## What Is a Naked Call?

A naked call is a risky strategy whereby investors sell call options without holding the underlying asset. Unlike covered calls, naked calls expose the writer to potentially unlimited losses if the stock price rises above the strike price, but can generate quick premium income if it expires out of the money. Find out how this strategy works and why it is suitable for only experienced investors.  

### Key Takeaways

*   A naked call is an options strategy where the investor sells call options without holding the underlying asset, making it highly risky with unlimited loss potential.
*   The only profit from a naked call is the premium received when the call is sold, and traders hope the option expires worthless to retain this income.
*   Because of the unlimited risks, brokers set high margin requirements and typically restrict this strategy to experienced investors with substantial capital.
*   Investors use naked calls to profit from expected declines or stability in securities, but risks include high volatility that can lead to extensive losses if the market moves unfavorably.

## How Naked Call Options Generate Income and Risk

Investors use naked call options to generate [premium income](https://www.investopedia.com/terms/p/premium-income.asp) without directly selling the underlying security. Essentially, the premium received is the sole motive for writing an uncovered call option.

It's inherently risky since there is limited upside potential and, in theory, unlimited downside losses. In fact, the maximum gain is the premium that the option writer receives upfront, which is usually credited to their account. So, the writer's goal is to have the option expire worthless.

The maximum loss is theoretically unlimited because there is no cap on how high the underlying security price can rise. Sellers usually repurchase options before the price rises too much above the strike price, depending on their risk tolerance and [stop-loss](https://www.investopedia.com/terms/s/stop-lossorder.asp) settings.

Therefore, the seller of call options wants the underlying security to fall so they can collect the entire premium if the option expires worthless. But if the underlying security price rises, they may have to sell the stock at a price far below the market price. This happens when the option buyer exercises their right to buy the security.

> **Important**
>
> Margin requirements are high due to the strategy's unlimited risk potential.

## Execution of the Naked Call Options Strategy

Again, there is a significant risk of losses with writing [uncovered](https://www.investopedia.com/terms/u/uncovered-option.asp) calls. However, investors who are confident that the expected price of an underlying security, usually a stock, will fall or stay the same can write call options to earn the premium. If the stock stays below the strike price between the time the options are written and their expiration date, then the writer of the option keeps the entire premium minus commissions.

However, if the stock price rises above the strike price by the option expiration date, the buyer of the options can demand the seller deliver shares of the underlying stock. The options seller will then have to go into the open market and buy those shares at market price to sell them to the buyer of the option at the option strike price.

For example, if the strike price is $60 and the stock price is $65 when exercised, the seller loses $5 per share minus the premium.  

## Evaluating Risks and Breakeven Points in Naked Calls

The writer's breakeven point is calculated by adding the option premium received to the strike price of the sold call. A rise in implied volatility is a problem because it increases the chance the option will be exercised. Since the option writer wants the naked call to expire out of the money, the passage of time, or time decay, is a positive outcome for this strategy.

Due to the risk involved, only experienced investors who are highly confident that the underlying security price will fall or remain flat should use this sophisticated strategy. The margin requirements are often very high for this strategy because of the possibility of open-ended losses, and the investor may be forced to purchase shares on the [open market](https://www.investopedia.com/terms/o/open-market.asp) before expiration if the margin threshold is crossed.

The upside to the strategy is that investors could receive income through premiums without putting up much initial [capital](https://www.investopedia.com/terms/c/capital.asp).

### Risk Management Strategies for Naked Call Writers

Risk management strategies can help mitigate losses, but naked call writing remains high risk even with many of these and other methods and is therefore not suitable for most investors. Understanding the risks involved thoroughly and having a solid grasp of options trading before writing naked calls is crucial. When doing so, here are some strategies for mitigating potential losses:

**Covered calls**: Obviously, the first way to mitigate risk is not to write naked calls in the first place. In this strategy, you own the underlying stock and sell call options against those shares. This limits your upside potential and reduces your risk, as you already own the shares you may be obligated to sell if the trade goes against you.

**Diversification**: Spread your naked call positions across underlying securities, sectors, and expiration dates. This can help reduce the impact of any position that moves against you.

**Fund your account well**: Ensure you have sufficient capital to cover potential losses and meet [margin](https://www.investopedia.com/terms/m/margin.asp) requirements. Don't overleverage your account.

**Position sizing**: Limit the size of your naked call positions relative to your overall portfolio. This helps to ensure that a single trade doesn't have an outsized impact on your portfolio.

**Spreads**: Use option spreads to limit risk. For example, a call credit spread involves selling a call option and simultaneously buying another call option with a higher strike price. This caps your maximum loss at the difference between the two strike prices minus the net premium received.

**Stop-loss orders**: As with other derivative trading, these are your best risk management tools. Place [stop-loss orders](https://www.investopedia.com/articles/stocks/09/use-stop-loss.asp#:~:text=A%20stop%2Dloss%20order%20is%20an%20order%20placed%20with%20a,limit%20your%20loss%20to%2010%25.) to automatically close out your position if the underlying security's price reaches a preset threshold. This would limit your losses if the market moves against you.

## Pros and Cons of Implementing Naked Call Strategies

### Pros and Cons of Selling Naked Calls

Pros

*   Generates immediate premium income
    
*   A way to short the market without selling short the underlying
    

Cons

*   Limited potential profits
    
*   Unlimited potential losses
    
*   High margin requirements from brokers
    

Naked call options are appealing because they allow earning premium income [without owning or shorting the underlying](https://www.investopedia.com/articles/optioninvestor/10/covered-call-no-stock.asp) security. The premium collected upfront is the primary source of profit in this strategy, credited to the investor's account immediately upon selling the call option. For those good at forecasting market moves, this strategy can be lucrative. Of course, it can be a disaster for those who aren't.

As such, the risks and downsides of the naked call strategy are considerable and warrant careful consideration. The most glaring issue is the strategy's inherent risk profile, which includes limited profit potential (strictly capped at the premium received) against theoretically unlimited losses if the underlying asset rises above the call's strike price. This imbalance stems from the fact that there is no upper limit to how high the underlying asset price can climb. If the market moves contrary to the investor's expectations, the costs to buy back the option or cover the position in the market can be exorbitant, leading to significant losses.

Large [margin deposits](https://www.investopedia.com/terms/m/margin.asp) are needed due to the high risk, protecting brokers. In addition, even if the underlying falls somewhat, an increase in implied volatility can work against the seller, raising the likelihood of the option ending in the money and being exercised, magnifying the risk of loss. Given these risks, the naked call strategy suits only seasoned investors with high risk tolerance and strong loss management strategies.

### Example

Le's use a scenario involving Tesla, Inc. ([TSLA](https://www.investopedia.com/markets/quote?tvwidgetsymbol=TSLA)), known for its volatility and significant price moves. In early 2024, Tesla's stock was trading at about $200 per share. Several investors pool their money and believe that Tesla's stock price will fall or remain at about that price in the short term. They write a naked call option with a strike price of $300, expiring in January 2025. The investors get a [premium](https://www.investopedia.com/terms/p/premium.asp) of $30 per option.

If Tesla's stock price remains below $300 by the expiration date, the call options will expire worthless, and the investor gets to keep the $30 premium. However, let's imagine Tesla announces some groundbreaking technology or significantly better-than-expected earnings, causing the stock to surge to $400 by the end of the year. In that case, the investor would be obligated to sell Tesla shares at the strike price of $300 or a loss of $100 per share, minus the $30 premium received, resulting in a net loss of $70 per share.

This example highlights the income-generating potential and the significant risks of naked call options, emphasizing why it's one of the riskiest options strategies.

## Why Is it Called a "Naked" Call?

The term "naked" refers to a strategy in which the seller (or writer) of the call option does not own the underlying asset that they must sell if the option is [exercised](https://www.investopedia.com/terms/e/exercise.asp). The "naked" aspect emphasizes the exposure to risk without the security of holding the underlying stock, as in being unprotected or exposed in financial terms.

## How Does a Covered Call Differ from a Naked Call?

A covered call strategy involves selling call options while simultaneously owning an equal number of shares in the underlying asset. This approach is considered safer than selling naked calls because the potential losses are offset by gains in the owned shares if the stock price rises. The primary goal of a covered call is to generate income through the premiums received, with the security of owning the underlying asset to cover the obligation if the option is exercised.

## Can Anyone Sell Naked Calls?

No, only those approved by their broker can typically sell naked calls. Understanding the high risks involved, the financial industry has erected specific measures to protect themselves and investors. Brokerages often impose higher margin requirements and proof of significant trading experience before allowing an investor to sell naked calls. These barriers are in place to ensure that only those with a deep understanding of market dynamics and the capacity to absorb potential losses venture into this high-risk territory.

## The Bottom Line

A naked or uncovered call strategy involves selling call options without owning the underlying asset, allowing the seller to receive immediate premium income from the buyer. The strategy is enticing for its income potential, as sellers keep the premium if the options expire worthless. However, it carries significant risk, as the potential losses are theoretically limitless if the underlying asset's price exceeds the strike price. This makes naked calls a high-stakes strategy, appropriate only for seasoned investors with a strong risk tolerance and a well-developed risk management plan.

> **Article Sources**
>
> 1.  R. Lehman and L. G. McMillan. "[Options for Volatile Markets: Managing Volatility and Protecting Against Catastrophic Risk](https://www.wiley.com/en-us/Options+for+Volatile+Markets:+Managing+Volatility+and+Protecting+Against+Catastrophic+Risk,+2nd+Edition-p-9781118022269)." John Wiley & Sons, 2021. Pages 38-40, 100-104.
>     
> 2.  SoFi. "[What Is a Naked Call Options Strategy?](https://www.sofi.com/learn/content/naked-calls/)"
>     
> 3.  John C. Hull. "[Options, Futures, and Other Derivatives](https://www.pearson.com/en-us/subject-catalog/p/options-futures-and-other-derivatives/P200000005938/9780136939917)." Pearson, 2022. Pages 268-287.
>     
> 4.  M. C. Khouw and Mark W. Guthner. [The Options Edge: An Intuitive Approach to Generating Consistent Profits for the Novice to the Experienced Practitioner](https://www.wiley.com/en-us/The+Options+Edge%3A+An+Intuitive+Approach+to+Generating+Consistent+Profits+for+the+Novice+to+the+Experienced+Practitioner-p-9781119212416), John Wiley & Sons, 2016. Pages 138-144.
>     
> 5.  Financial Industry Regulatory Authority. "[Options: Risks](https://www.finra.org/investors/investing/investment-products/options#risks)."