Uncovered Options

Contrary to "covered options", the issuer of "uncovered options" does not hold the respective opposite position in the underlying. We further differentiate between selling uncovered calls and uncovered puts. For a premium, the issuer of an uncovered or naked call agrees to provide the underlying at some point in time in the future for a price determined in the present.

As security and proof of his ability to deliver in the future, the issuer needs to deposit a margin of the option premium plus about 10–20% of the underlying with his broker. The risk of such a transaction is virtually unlimited.

The issuer of a call expects prices to fall or at least a sideways movement of prices for the underlying on the one hand and judges the option premium to be overvalued on the other hand.

For the issuer this means that the (overvalued) option premium overcompensates the price change risk, included in the underlying. The risk of rising prices and hence the execution of the option can however be eliminated or mitigated at any time by closing the position or buying the underlying, in which case the option is transformed into a covered call.

When dealing with an uncovered put, we can assume that the issuer of the put neither sold the corresponding underlying short nor has the money to buy the underlying. Compared with the uncovered call, again a limited possible return—the premium—faces a substantial risk.

If the price of the underlying falls by an amount surpassing the premium, the issuer of the put faces a loss, which may end up being a multiple of his initial capital invested, but however, is limited by the complete loss of the underlying. The primary goal for the issuer of a put is to make a profit by obtaining the option premium, and by buying the underlying for a price below the market price.

Uncovered Options
Uncovered Options
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