The Naked Call option strategy is used by beginners as well as seasoned options traders. It is a simple way to learn options and one that can add some extra income to your investment portfolio.
In this article we are going to cover :
What is a Naked Call?
Buying versus selling a Naked Call
Benefits of Selling a Naked Call?
When do we use a Naked Call?
How do we manage a Naked Call?
How do we put on a Naked Call?
And we will show you using a real example on the TastyWorks Option Trading Platform.
Let’s jump right into it.
What is a Naked Call Option?
A Naked Call is an option strategy where you sell a Call Option without owning the underlying stock nor buying another Call as a stop loss.
It is considered a Naked Call because you are “naked” or exposed to the risk of having to sell shares of the underlying stock at the strike price if the option is exercised by the buyer.
Selling a Naked Call is a bearish strategy because you are expecting the stock price to go down. When it goes down or stays where it is at you profit!
Buying Versus Selling A Naked Call
You can either buy or sell a Naked Call. The picture above shows shorting or selling a naked call.
If you sell a Naked Call, you are obligated to sell shares of the underlying stock at the strike price if the option is exercised.
However, if you buy a Naked Call, you have the right to purchase shares of the underlying stock at the strike price but are not obligated to do so.
The picture below shows buying a naked call.
What are the benefits of selling a Naked Call?
There are a couple advantages to selling a Naked Call.
The first advantage is that it can be used as a way to bet against a stock that you believe is overvalued and postioned to move down in price. In order to bet against a stock that you believe is overvalued, you can short it. Shorting just means to sell shares against it. It is the opposite of being long or buying the stock. By selling a naked call you above the current price of the stock you can collect premium. If the stock moves down you can continue to sell calls and roll to the next month. If the stock moves up then you get to short the stock at a higher price than you would have at the current market price when you put the trade on.
The second advantage is that it can be used as a way to generate income from your investment portfolio. This is because when you sell a call you collect the premium which is like getting paid for taking on the risk of having to sell shares of the underlying stock.
Lastly, selling a Naked Call requires less buying power than shorting the stock outright. This allows the opportunity to make a higher ROI Return On Investment.
What are the downsides to selling a Naked Call?
You need to be comfortable with the risks involved in selling a Naked Call. The biggest risk is that the stock price can go up and you may be assigned the short stock. If the stock continues up you lose more money.
If the stock price goes down too much you will miss out on additional profits that you would have had if you shorted the stock outright. However, we shouldn’t allow ourselves to think this way since we keep the premium collected upfront.
Now let’s talk about when to sell a Naked Call.
When should you Sell a Naked Call?
A Naked Call can be sold in several different situations.
It is a good strategy to use when you are bearish on a stock and think the price will go down.
It can also be used as a way to short a stock at a higher price. So if you are bearish on the stock and want to short it, why not sell a Call and try to get in at a higher price? You can collect premium in the meantime.
Lastly, it is a good strategy to use to generate income from your investment portfolio. When you sell the naked call you collect a premium. If you are not assigned, you can roll the put to the following month and collect additional premium. You can continue doing this every month until you are assigned.
Selling naked calls is a way to add negative delta to your portfolio to make it more delta neutral as opposed to just being long everything. So that you can profit if the market moves down as well as up.
How do we sell a Naked Call?
Selling a Naked Call is relatively simple.
First, you need to choose the stock or ETF that you want to sell a Call on. You want to make sure that you are bearish and believe the stock price will decrease in value.
Next, you need to choose the expiration date of the option contract. I suggest selecting the date that is closest to around 45 days to expiration. We pick this expiration date to maximize profit and minimize risk.
Lastly, you need to choose the strike price. This is the price that you are willing to sell shares of the underlying stock at.
That’s it! You have now sold a Naked Call.
Now let’s look at how to manage a Naked Call position.
How Do We Manage A Naked Call?
When trading short naked options, selling an option of the opposing type (i.e. buying a call against a short call that is being “tested”) can be one defense mechanism. This reduces the directional risk of the position and collects more premium, which extends the break-even point.
If the trader’s assumption on the underlying has not changed as expiration approaches, the position can be rolled to the next expiration cycle to extend the time in the trade and collect more premium.
When do we close a Naked Call?
Profitable Short Naked Calls will be closed at a more favorable price than the entry price (first goal: 50% of maximum profit)
How Do We Lose With A Short Naked Call?
It is very possible to lose when selling a Naked Call. The underlying stock price could rise, in which case you would be assigned the short shares of the stock at the strike price and your loss would be equal to the difference between the strike price and the entry price, minus the premium collected.
The maximum loss for a naked call is unlimited as there is no limit to how high the underlying stock price can go up.
Selling A Naked Call Example
To better understand how selling a Naked Call works, let’s look at an example.
We are going to sell a naked put in KSS Kohls since it is near the top of its range over the last 12 months. We will use the TastyWorks Trade platform. By the way I’ll put the link in the notes below if you want to open an account and get the free stock promotion. It is the option trade platform that I use most of the time and I think it’s the best for trading options.
So we are going to go to the trade tab and punch in the ticker KSS up above. I like to use the curve mode so that I can visually see the profit zone in green.
We go to the strategy tab and hit Short Call Option. The TastyWorks platform will automatically set you up to sell a short call.
In this case we are selling the 65 strike call for 1.97 with 35 days to expiration. So we are collecting $197 immediately upon placing this trade.
The BP effect which is buying power we are using is $837. So it is a cost-efficient way of investing since are using $837 and collecting $197.
Now if you look at the green area which is the P&L at expiration, we see the max profit is the $197 which is the amount we collected upfront. As long as the stock stays below the 65 strike price we keep the max profit.
We don’t start losing money until the stock moves up to 67. So if it stays where it is at, moves lower or even moves up a little we still profit.
If the stock moves up above the 67 strike price we can be assigned at or before expiration. In that case we will be short 100 shares (equal to 1 option contract) at $65. This price is still better to sell at than the current price of $61.
So from here we hit review and send and then send order to place the trade.
We now have a 65 short naked call in Kohls!
Conclusion
The short naked call is strategy is a great strategy for generating income and selling a stock that you are bearish in at a better price than the current price.
Always do your research and consider your investment goals before you begin trading stock options. For more stock and financial information, please check out our other resources at OptionsFinanceProfits.com.
