A naked option, also known as an "uncovered option," is an option contract entered into where the seller does not actually own any, or enough, of the underlying stock. When the buyer exercises the option, the seller must purchase the shares and sell them under the terms of the option contract.
There are two naked options:
- Naked call option: making a short position in the seller's account.
- Naked put option: making a long position in the seller's account, purchased with available cash.
Traders and investors prefer naked options because the predicted volatility is already factored into the price. However, there is a risk of large loss if the price changes dramatically before expiration.
[Last updated in March of 2022 by the Wex Definitions Team]