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Naked Call Write

How Does Naked Call Write Work in Options Trading?

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Naked Call Write - Introduction

Naked Call Writes are sometimes known as a Call Write, Naked Call, Write Call Options, Short Call, Uncovered Call Write, Selling Naked Calls or Short Call Options.

A Naked Call Write is when you Sell To Open Call options without first owning the underlying stock.

Which means that you are selling the right to buy the underlying stock at a certain price without even owning the stock in the first place... like signing a contract to sell a car when you do not even have that car...yet. If the stock falls, you get to keep the whole cost of the call options as profit as the call options expire out of the money.

Find Options Strategies With Similar Risk Profiles Find Options Strategies With Similar Risk Profiles

One should be familar with Call options before executing this strategy. Please read all about Call options here.

When you Sell To Open a Call option in this Naked Call Write strategy, you are essentially playing the role of a banker where you sell the Call options to someone who is betting on the underlying stock to go up. If this person is wrong and the stock drops, you keep the money he/she paid you for the Call options if the Call options expires Out Of The Money ( OTM ). If this person is correct and the stock rises, you, as the banker, suffers a loss. That is how a Naked Call Write works in a nutshell.

Complex bearish option strategies, such as the Naked Call Write, usually have added benefits such as profiting even if the underlying stock stays stagnant or even profiting if the underlying stock should rise slightly instead of drop. The Naked Call Write, as the simplest of the complex bearish option strategies, is no exception. By writing a Call option, you are not only making money if the underlying stock drops due to delta effect, you also have Time Decay, which is the biggest evil of buying stock options, in your favor as Time Decay works against the favor of the buyer of the Call options that you sold. Yes, this means that if the options you sold failed to rise in price, you also profit from its premium value!

Naked Call Write is a credit strategy where you recieve cash for putting on the position. This puts the broker at risk if you are not able to cover the position when required. This results in most option trading brokers asking for a fairly high margin before one is allowed to execute this strategy.

When To Use Naked Call Write?

One would use a Naked Call Write when speculating a small or moderate drop in the underlying stock. This drop need not be a dramatic one like in the Long Put Options strategy as it only need to drop enough to allow the Call options to expire out of the money (OTM).

Example : Assuming QQQQ at $44. Sell To Open 10 QQQQ Jan44Call for $0.80.
You will make the entire $0.80 in profit even if the QQQQ expires at $43.95.

If you are expecting a huge, dramatic drop in the underlying stock, you would use a Long Put Options strategy instead because, using the Naked Call Write as in the example above, you would make only $0.80 no matter how low the underlying stock drops to.

How To Use Naked Call Write?

A Naked Call Write is a simple option strategy where you simply sell to open Call options at a strike price which you are confident that the underlying stock would drop below by option expiration. One would usually sell Call options of the nearest expiration month so that the underlying stock would not have time to go back in the money (ITM).

Example : Assuming QQQQ at $44.
If you expect QQQQ to fall to $43, you could Sell To Open QQQQ Jan43Call.
If you expect QQQQ to fall very slightly, you could Sell To Open QQQQ Jan44Call.

The deeper In The Money (ITM) Call Options that are written, the higher your maximum profit potential but the more QQQQ needs to move in order to expire that option out of the money (OTM).

Here is a table showcasing the differences:

Assume QQQQ Trading At $44 Now.
Strike Price Price Amount QQQQ Needs
To Drop For Max Profit
Profit If QQQQ
Expires @ $43.99
$45 $0.10 0 $0.10
$44 $0.80 $0.01 $0.80
$43 $1.80 $1.01 $0.81

Trading Level Required For Naked Call Write

A Level 5 options trading account that allows the execution of naked writes is needed for the naked call write. Read more about Options Account Trading Levels.

Profit Potential of Naked Call Write

The Naked Call Write has a limited profit as the most one could make is the price at which the Call option is sold no matter how low the underlying stock drops to. The Naked Call Write also profits from the premium value decay even if the underlying stock stays stagnant. This enables the Naked Call write to have a much higher chance of turning a profit than a simple Long Put Option strategy.

Profit Calculation of Naked Call Write

There are 2 ways to calculate profit for Naked Call Write : Before Expiration and After Expiration.

Before Expiration
Before expiration, the Naked Call Write profits from a fraction of the move in the underlying stock based on its delta value and a fraction of the Call option's premium value due to time decay based on it's theta value.

Following up from the above example:
Sell to open 1 lot of QQQQ Jan44Call for $0.80 per contract with a delta value of 0.5 and theta value of 0.018.

QQQQ falls to $43.20, 5 days later.

Profit = [(Drop in underlying stock) x delta value] + [(theta x number of lots) x number of days] / price of Call options

Profit = [($44 - $43.20) x 0.5] + [(0.018 x 1) x 5] / 0.8 = 61.25% profit.

OppiE's Note Please note that the above figures are only arbituary and that precise calculation of expected profit before expiration can only be arrived at using a stock option pricing model such as the Black Scholes Model.

After Expiration
Upon expiration, there can be 2 possible scenarios for the Naked Call Write :

1. The underlying stock drops lower than the strike price
When the underlying stock is trading lower than the strike price of the Call options that you sold upon expiration, those Call options expires out of the money (OTM) and the entire price of the Call options that you sold becomes your profit.

2. The underlying stock is trading higher than the strike price
Profit / Loss = Net Credit - (Strike Price - Stock Price)

Following up from the above example:
Sell to open 1 QQQQ Jan44call for $0.80 per contract.

If QQQQ rises to $44.5 at expiration.

Profit = $0.80 - ($44.5 - $44) = $0.30 or 37.5%

If QQQQ rises to $46 at expiration.

Loss = $0.80 - ($46 - $44) = -$1.20

Risk / Reward of Naked Call Write

Upside Maximum Profit: Limited
Limited to net credit recieved.

Maximum Loss: Unlimited

OppiE's Note Because you can lose an unlimited amount of money as long as the underlying stock continues to rise, you should always place a reasonable stop loss when executing a Naked Call Write.

Break Even Point of Naked Call Write

The breakeven point for a Naked Call Write is the point beyond which the underlying stock can rise before the position starts to go into a loss. This is calculated as:
Breakeven = Strike Price + premium value of Call options sold.

Following up from the above example:
QQQQ is trading at $44 and QQQQ's Jan44Call is At The Money and has no intrinsic value. The whole price of $0.80 is premium value. Thus the breakeven point would be $44 + $0.80 = $44.80. QQQQ needs to rise above $44.80 before the position starts making a loss.

One would notice by now that a Naked Call Write has a much higher chance of a profit than simply Long Put Options as you will make money even if the stock does not move and lose money only when the stock rises above the breakeven point.

Naked Call Write Questions

:: "Breakeven Point for Naked Call Write?"

Advantages Of Naked Call Write

:: As the strategy results in a net credit, risk is reduced.

:: It is a simple option strategy which requires no precise calculation to execute, unlike other more complex option strategies.

:: As it involves trading only one kind of option, the commissions involved would be much lower than the rest of the other more complex option strategies

:: It allows you to profit even if the underlying stock stays completely stagnant.

:: It is a versatile option strategy which can be transformed into other option strategies in order to accomodate changing market outlooks prior to expiration.

:: Unlike in a Long Put Option, a Naked Call Write offers you a degree of protection from loss if the underlying stock should rise slightly instead of fall.

Disadvantages Of Naked Call Write

:: Potential profit is limited, so if the stock goes into a huge drop, one could miss out on the profit opportunity.

:: Potential loss is unlimited and one could lose a lot of money if the underlying stock rises drastically.

:: As Naked Call Write is a credit strategy that involves margin, beginners are rarely allowed to execute it with most online brokers.

:: As margin requirements can be quite large, one may not be able to Call on as many positions as one may simply by buying put options.

Adjustments for Naked Call Write Before Expiration

1. If the underlying stock has moved so much as to leave the Call options with very little value left before expiration, one may wish to buy to close the Call options in order to profit these profits instead of risking it all by holding till expiration.

2. If the underlying stock is about to rebound after it's drop is over, you could transform the Naked Call Write into a Bull Call Spread by buying an equivalent number of At The Money (ATM) Call options.

3. If the underlying stock proves to be trading within a narrow trading range, one could transform Naked Call Write into a Short Strangle by further Selling To Open a corresponding number of Out Of The Money (OTM) Put Options.

Alternate Actions for Naked Call Write During Expiration

1. One should always allow Out Of The Money (OTM) Call options to expire and always Buy To Close these Call options if they are In The Money (ITM).

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