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.