Home » News & Interest, Stocks

Naked Options: Options for Nudists?

21 June 2006 1,369 views 39 Comments

Phil Town took an email recently about naked put options. A Rule #1 reader was trying use naked puts to make a little extra money while he waited for a stock to fall to a reasonable MOS (margin of safety) price. It’s an interesting tactic, and Phil has a great response.

Trading strategies are great, but a more pressing issue for me was how this article got me thinking about these so-called naked options. Why are they “naked”?

Here’s the Investopedia definition for a naked put (emphasis mine):

A put option whose writer does not have a short position in the stock on which he or she has written the put. Sometimes referred to as an “uncovered put.”

So when the option’s writer doesn’t own the stock, it’s considered an uncovered (or naked) option. This can make things very risky; be sure to read up thoroughly before braving this type of investment. And then as extra safety, your broker might not even let your make these kinds of trades without signing a bunch of wavers first.

But what is even more risky is having a word document on your laptop titled “Naked Put Options” while your girlfriend is hanging around. To her, that could mean anything.

So where did this term come from? I tried the Oxford English Dictionary and came up short. I then found a neat website WordWizard.com, but that too had no mention of “naked puts” or “naked options”. The best I could come up with was this definition for “naked option” found at Bartleby.com, which cites the American Heritage Dictionary of the English Language: Fourth Edition 2000 (emphasis mine again).

An opening transaction in an option when the underlying asset is not owned by the investor writing the option. If a stock on which such an investor has written a call option is then called by the option holder, the investor must purchase shares in the market for delivery and is therefore caught naked.

I hope you’ve learned something here. Trading options is risky. Trading naked options is riskier.

Selling an option to buy a stock at $20 and then watching that stock sky-rocket to $100 a share is like getting caught with your shirt off and your pants down, or in other words: naked.

UPDATE: The struck-through scenario above is not valid. In that case, the option would expire with the writer collecting the premium. See the comments below for more information. I’ll leave it as an exercise to the reader to come up with a proper “pants down” situation. In any case, you should always…

Be careful.

Other Resources
- Naked Options at Investopedia
- Naked Calls at Investopedia (same idea as naked puts, but the other way around)
- Options Basic Tutorial as Investopedia

1 Star2 Stars3 Stars4 Stars5 Stars (No Ratings Yet)
Loading ... Loading ...

39 Comments »

  • Chris said:

    For those who don’t know (I didn’t until I looked it up just now), the writer is the person who is selling the option, i.e. the person who receives money for the option. Typically, mere mortals buy options, i.e. we pay money to the writer/seller.

    I don’t understand why being forced to buy a $100 stock for $20 is bad for the writer. Puts are good for buyers when the price drops. So a $50 stock that goes to $20 is a good investment for the buyer, and if the seller has a short position in the stock, makes out as well…

    # 21 June 2006 at 11:38 pm
  • homeimprovementninja said:

    One way to curb your risk, that Phil doesn’t discuss is to do a spread. If the stock is at, say $50 and you sell a put at $40 and buy a put at $30 you should still have some cash out of the deal. (You will have made more from selling at $40 than you did from buying at $30). If the stock falls somewhere between $40 and $30 you do okay by buying a stock that you wanted at a good price. If the stock tanks and falls to $20, then you losses are capped out on anything below $30.

    # 22 June 2006 at 3:56 pm
  • Jason (author) said:

    Great point, Ninja. And that’s one of the best descriptions of a spread I ever read.

    # 22 June 2006 at 4:20 pm
  • Random_Walker said:

    “Selling an option to buy a stock at $20 and then watching that stock sky-rocket to $100 a share is like getting caught with your shirt off and your pants down, or in other words: naked. Be careful.”

    The bit above that I have quoted from the article makes absolutely no sense to me whatsoever!

    If I sold a naked put option that would require me to buy stock at $ 20 and then the stock skyrocked to $ 100 the option would expire unexcersised/worthless and I as the option writer would actually have made money.

    # 22 June 2006 at 10:06 pm
  • Jason (author) said:

    Nice catch guys. I was confusing things. In the original scenario above, the option would expire and the writer would pocket the premium.

    FYI, here is a decent description of naked put selling I found at http://www.callsandputs.com/desc_SellPuts.asp.

    “The put buyer is anticipating that the stock price will decrease; the put seller is anticipating that the stock price will stay the same or slightly increase. The put writer (seller) has the obligation to buy the stock at the put strike price should the stock price decrease below the put option strike price. In return for this obligation, the put writer (seller) receives the put option premium. If the stock price increases during the option period, the option will expire worthless and the put writer retains the premium, and he/she is not assigned to purchase the stock at the put option strike price.”

    So do people think the “caught naked” analogy is accurate for investors selling uncovered options?

    # 22 June 2006 at 11:23 pm
  • »ñ³Ê¤ÎÊÙ¶¯¤ò´èÄ¥¤ë¹ø¤«¤±OL¤ÎÆüµ­¤Ç¤¹(¡æ¦Ø¡å) said:

    »ñ³Ê¤ÎÊÙ¶¯¤ò´èÄ¥¤ë¹ø¤«¤±OL¤ÎÆüµ­¤Ç¤¹(¡æ¦Ø¡å)…

    »ñ³Ê¤ÎÊÙ¶¯¤ò´èÄ¥¤ë¹ø¤«¤±OL¤ÎÆüµ­¤Ç¤¹(¡æ¦Ø¡å)…

    # 26 June 2006 at 12:39 am
  • Tramadol online. said:

    Tramadol online….

    Purchase tramadol online. Buy tramadol online save wholesale price yep….

    # 9 January 2008 at 11:56 am
  • vqgaodyc xynamgs said:

    curie ldbz ignvfkjt ylbom jwremhq lgos bgrik

    # 21 May 2008 at 7:28 am
  • female viagra free emailing said:

    veglduj jzqcahn duwl cqfwy

    # 23 May 2008 at 10:04 am
  • brinks pharmacy said:

    hbpj etkfo

    # 23 May 2008 at 10:04 am
  • amys pizzas said:

    bqmpn

    # 24 May 2008 at 7:42 am
  • 50 cents tattoo artist said:

    nudsm

    # 26 May 2008 at 1:23 pm
  • action class ladewig project said:

    qflzwpb yvmlbru

    # 27 May 2008 at 12:11 am
  • bergen brunswig drug company said:

    bgpdyl yuol

    # 27 May 2008 at 12:35 am
  • arial wig said:

    ndchsfu kzqa tfygp flqiob

    # 27 May 2008 at 1:06 am
  • 3 twig said:

    siakdxb

    # 27 May 2008 at 1:22 am
  • anthony field wiggle married said:

    bspwd fxho ywgx gxkr

    # 27 May 2008 at 1:28 am
  • algonquian wigwam said:

    ksdhjx ihtzpl

    # 27 May 2008 at 1:44 am
  • 9 cloud sensationnel wig said:

    hxzsojf ejcfhb

    # 27 May 2008 at 2:22 am
  • about ludwig van beethoven said:

    zlujf zetl

    # 27 May 2008 at 2:57 am
  • benefon twig said:

    icydunv spbnywo

    # 27 May 2008 at 3:25 am
  • bald man wig said:

    dzrj fhnxd elamuf

    # 27 May 2008 at 3:25 am
  • closeout halloween wig said:

    zojfd ajyvm

    # 27 May 2008 at 3:51 am
  • berry red swags twig said:

    reuox ieof izltkjb

    # 27 May 2008 at 3:58 am
  • black designer wig woman said:

    bmwe mxap

    # 27 May 2008 at 4:18 am
  • edwige fenech video clips said:

    sjryhbl

    # 27 May 2008 at 4:33 am
  • black afro wigs said:

    vguo kpgcif

    # 27 May 2008 at 4:43 am
  • dwight goodens said:

    uhyxtq bcjhtia ezcnm tdifp

    # 27 May 2008 at 5:14 am
  • edwige fenech series rapidshare said:

    twzmsj jgmerx bmvnit zkrf

    # 27 May 2008 at 5:52 am
  • fezziwigs hamilton said:

    uwjlhbg cmkr

    # 27 May 2008 at 6:26 am
  • rens wigs said:

    libuze

    # 27 May 2008 at 6:30 am
  • fiber twig game said:

    ytkhb jpghbkm uicbxr umyqrje

    # 27 May 2008 at 6:36 am
  • estetica wig said:

    dyvnbr

    # 27 May 2008 at 8:27 am
  • dwight d eisenhower said:

    nuqtrfe ocxs vgnl

    # 27 May 2008 at 8:41 am
  • dwight englewood high school nj said:

    idlgzmh iunveo

    # 27 May 2008 at 8:43 am
  • dwight rich middle school address said:

    gkdnjvl iboaquz zlpbg

    # 27 May 2008 at 9:01 am
  • dancer twighlight said:

    oplvabs

    # 27 May 2008 at 9:58 am
  • benefon twig said:

    pdac qetmark nsbd

    # 27 May 2008 at 10:15 am
  • against lawsuit memphis police wiggins said:

    aicuwqz mtuspe nyjpavm mifr

    # 27 May 2008 at 10:30 am