A cura di Walter Snyder, WWS Swiss Financial Consulting SA
With the stock market turmoil taking its toll on FAANG stocks, it might be useful to examine what it means to sell a naked call. Experienced traders already know what this entails and can spare themselves reading further. Many retail investors who are thinking about trading will find this Newsletter useful.
Options trading can easily result in substantial losses if one is not careful. OptionsSellers.com was not careful and not only had to be liquidated, but investors in the company found that they had to put up more money to cover the losses incurred by selling naked calls. An options contract is just that, a contract. There is a seller and a buyer. The buyer gives the seller a premium in order to have the contract. The seller assumes certain obligations in relation to the buyer.
One contract is for one hundred shares if the underlying, that is, the thing that the contract is based on, is a stock. The underlying could be a commodity or something else. The option is limited in time, usually for one, two or three months. Options usually expire worthless, and the buyer losses the money that he paid for the option.
However it is possible for the buyer to make some money if the price of the stock in a call option goes up and over a certain agreed price, the strike price.
If the price of the stock or underlying never reaches the strike price, then the option is “out of the money”. If the market price goes up and reaches the strike price, then the option is “at the money”. If the market price goes up and over the strike price, then the option is “in the money”, and the buyer of the option can exercise the option and insist that the seller of the option sell him the shares or underlying at the strike price even if the market price is higher than the strike price. A naked call means that the seller has “written” or sold the call option without having the underlying to ”cover” the option if the buyer exercises his rights. The seller then has to buy the underlying on the market at the higher price and sell the underlying to the buyer of the option at the strike price.
OptionsSellers.com thought that the underlying in their naked call options would never go up higher than the strike price in the options that they sold. That was a fatal mistake. Gas prices spiked just before the options were due to expire, and that put the company out of business and meant that investors were liable for losses incurred by the naked calls. Options sellers beware of selling naked calls because the incurred risk is not worth the premium of the option!