Writing a Naked Call, Writing Covered and Naked Puts

A naked call occurs when the writer is not the owner of the underlying stock, which limits losses in case the stock increases quickly its prices. For example, let´s pretend that the writer writes a naked call in Citigroup stocks, for which the writer receives a Premium of $2 per share with a strike price of $50 per share. If Citigroup drastically raises its prices at $90 per share and the buyer of the option exercises the call, the writer will end up with a great loss. The writer receives $50 per share (the strike price) plus the Premium price of $2 per share but just as well will have to pay $90 per share to buy the stock to give it to the buyer. Sure that if the writer anticipates the raise in prices he would buy the Citigroup stock at a lower price before it goes up or would buy again the option to cover its position.

Writers of naked (or uncovered) options, calls and puts must deposit the required margins with their brokerage firms, while the writers of covered options do not need to deposit any money with their brokerage firms.

Investors can profit from writing naked calls in stocks which prices are declining or that are relatively steady below the strike calls for calls.

Writing covered puts
A put is the opposite position to a call. The writer of a covered put would sell short the underlying stock and would receive a Premium for the covered put. If the option is exercised the writer would buy the stock gain at strike price and would use the shares to close its short position.

Writing covered put options is rare because if the writer sells the stock short the writer expects the stock to reduce its prices. If the stock raises its prices, it would not benefit the writer to write a covered put because the option would  not be exercised, and the writer would have to buy the stock again at a higher price to close out the short sale.

Writing naked puts
The writer of a put option expects the stock to go up or at least not to lower its prices. If the put writer does not own an underlying stock, the contract is a naked or uncovered put, which needs the writer to make a fixed amount deposit with its brokerage firm for the required margins That way, without owning the underlying stocks, in case of a potential loss this is not cushioned if prices of stock drop rapidly.

For example, when Citigroup´s stock market price is at $45 per share, and if an investor writes a naked put in Citigroup with a strike price of $45 and receives a Premium per share of $2, the writer has the same potential loss as if it owned the shares. If the shares decline , the writer would lose money.

For example, if Citigroup´s stocks fell to $40 per share, the wrieter wuld have to buy Citigroup at $45 at exercise, resulting in $300 loss ($4500 - $4000 + $200).

The most that one can lose per share is $43 (the price of the stock up to $45 per share if Citigroup declines to $0 before expiration minus the option Premium of $2 per share).

If the price of Citigroup´s stock raises above $45 per share, the put option will not be exercised, and the minimum profit that the writer would get is $200.