CAN YOU PROVIDE AN EXAMPLE OF THE RISK OF NAKED CALL WRITING? - ProProfs Discuss
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Can you provide an example of the risk of naked call writing?



Asked by Layla, Last updated: Oct 16, 2021

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John Smith

John Smith

John Smith
John Smith

Answered Sep 08, 2016

Example:you buy one xyz corp. april call option with a strike price of 50 and a premium of $2when the stock itself is trading at $50. the underlying stock rises from $50 to $60 soyou decide to exercise your option (since the price of the stock is well above the strikeprice).a naked call writer is assigned the obligation of fulfilling the other end of your exercisedoption. since you bought a call option, you are entitled to buy 100 shares of xyzcorporation at a price of $50. the naked call writer must sell you 100 shares of xyzcorporation shares at a price of $50. problem is, the naked call writer doesnt own anyof the stock to sell you. so the naked call writer must first purchase the shares in themarket. the current market price is $60 per share. so the writer buys 100 shares at$60 per share and then sells the shares to you for a price of $50.the naked call writer received a premium when the call option was written - assume itwas a $2 premium at the time the call was written. as such, the naked call writergained $2 per share from the premium, but lost $10 per share on the sale of the stock,for a total loss of $8 per share.now, imagine what would happen if the stock price had continued to climb higher to$70 or $80 or $100 per share.
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