EXHIBIT 1.3 Naked Target call.
If TGT is trading below the exercise price of 50, the call will expire
worthless. Sam keeps the 1.45 premium, and the obligation to sell the stock
ceases to exist. If Target is trading above the strike price, the call will be in-
the-money. The higher the stock is above the strike price, the more intrinsic
value the call will have. As a seller, Sam wants the call to have little or no
intrinsic value at expiration. If the stock is below the break-even price at
expiration, Sam will still have a profit. Here, the break-even price is $51.45
—the strike price plus the call premium. Above the break-even, Sam has a
loss. Since stock prices can rise to infinity (although, for the record, I have
never seen this happen), the naked call position has unlimited risk of loss.
Because a short stock position may be created, a naked call position must
be done in a margin account. For retail traders, many brokerage firms
require different levels of approval for different types of option strategies.
Because the naked call position has unlimited risk, establishing it will
generally require the highest level of approval—and a high margin
requirement.
Another tactical consideration is what Sam’s objective was when he
entered the trade. His goal was to profit from the stock’s being below $50