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+Qapter 5: Naked Call Writing 133 
+THE UNCOVERED (NAKED) CALL OPTION 
+When one sells a call option without owning the underlying stock or any equivalent 
+security (convertible stock or bond or another call option), he is considered to have 
+written an uncovered call option. This strategy has limited profit potential and theo­
+retically unlimited loss. For this reason, this strategy is unsuitable for some investors. 
+This fact is not particularly attractive, but since there is no actual cash investment 
+required to write a naked call ( the position can be financed with collateral loan value 
+of marginable securities), the strategy can be operated as an adjunct to many other 
+investment strategies. 
+A simple example will outline the basic profit and loss potential from naked 
+writing. 
+Example: XYZ is selling at 50 and a July 50 call is selling for 5. If one were to sell the 
+July 50 call naked - that is, without owning XYZ stock, or any security convertible into 
+XYZ, or another call option on XYZ - he could make, at most, 5 points of profit. This 
+profit would accrue if XYZ were at or anywhere below 50 at July expiration, as the 
+call would then expire worthless. If XYZ were to rise, however, the naked writer 
+could potentially lose large sums of money. Should the stock climb to 100, say, the 
+call would be at a price of 50. If the writer then covered (bought back) the call for a 
+price of 50, he would have a loss of 45 points on the transaction. In theory, this loss 
+is unlimited, although in practice the loss is limited by time. The stock cannot rise an 
+infinite amount during the life of the call. Clearly, defensive strategies are important 
+in this approach, as one would never want to let a loss run as far as the one here. 
+Table 5-1 and Figure 5-1 (solid line) depict the results of this position at July expira­
+tion. Note that the break-even point in this example is 55. That is, if XYZ rose 10%, 
+or 5 points, at expiration, the naked writer would break even. He could buy the call 
+back at parity, 5 points, which is exactly what he sold it for. There is some room for 
+error to the upside. A naked write will not necessarily lose money if the stock moves 
+up. It will only lose if the stock advances by more than the amount of the time value 
+premium that was in the call when it was originally written. 
+Naked writing is not the same as a short sale of the underlying stock. While both 
+strategies have large potential risk, the short sale has much higher reward potential, 
+but the naked write will do better if the underlying stock remains relatively 
+unchanged. It is possible for the naked writer to make money in situations when the 
+short seller would have lost money. Using the example above, suppose one investor 
+had written the July 50 call naked for 5 points while another investor sold the stock 
+short at 50. If XYZ were at 52 at expiration, the naked writer could buy the call back 
+at parity, 2 points, for a 3-point profit. The short seller would have a 2-point loss.