CHAPTER 5 
Naked Call Writing 
The next two chapters will concentrate on various aspects of writing uncovered call 
options. These strategies have risk ofloss if the underlying stock should rise in price, 
but they offer profits if the underlying stock declines in price. This chapter on 
naked, or uncovered, call writing - demonstrates some of the risks and rewards 
inherent in this aggressive strategy. Novice option traders often think that selling 
naked options is the "best" way to make money, because of time decay. In addition, 
they often assume that market-makers and other professionals sell a lot of naked 
options. In reality, neither is true. Yes, options do eventually lose their premium if 
held all the way until expiration. However, when an option has a good deal of life 
remaining, its excess value above intrinsic value what we call "time value premium" 
- is, in reality, heavily influenced by the volatility estimate of the stock. This is called 
implied volatility and is discussed at length later in the book. For now, though, it is 
sufficient to understand that a lot can go wrong when one writes a naked option, 
before it eventually expires. As to professionals selling a lot of naked options, the fact 
is that most market-makers and other full-time option traders attempt to reduce their 
exposure to large stock price movements if possible. Hence, they may sell some 
options naked, but they generally try to hedge them by buying other options or by 
buying the underlying stock. 
Many novice option traders hold these misconceptions, probably because there 
is a general belief that most options expire worthless. Occasionally, one will even hear 
or see a statement to this effect in the mainstream media, but it is not true that most 
options expire worthless. In fact, studies conducted by McMillan Analysis Corp. in 
both bull and bear months indicate that about 65% to 70% of all options have some 
value (at least half a point) when they expire. This is not to say that all option buyers 
make money, either, but it does serve to show that many more options do not expire 
worthless than do. 
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