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Naked
Call Options
Function:
Speculation
Outlook:
Bearish
When someone writes (sells) call
options against stock that they do not own, the calls are
called "naked calls." They are naked because they
expose the seller to unlimited losses. If someone owns calls
on a stock and sells an equal or lesser number of calls against the
same stock, they calls sold are not considered naked because the
calls he owns are server as collateral.
Since writing naked calls expose the writer to virtually unlimited
losses, most brokers usually require that the writer have a minimum
cash balance in his account, usually $100,000 or more.
Example:
Advance Micro Devices (AMD) trades for $15, and you think it will go
down in price within the next month. You sell ten one-month
call contracts with a strike price of $16 for $.95, netting you
$950.00 (10 contacts x 100 shares per contract x $.95 per
share). If the stock closes anywhere below $16 on the day of
expiration, you get to keep the full $950. If it closes
anywhere above $16, you are obligated to buy 1,000 shares (10 x 100)
at the market price and sell them for $16. Thus, if the stock
goes to $21, you will lose $4,150 ($21,000 - $16,000 + $950).
You could also simply buy the calls back at a price of $5 per share
($21 - $16), which will still result in a net loss of $4,150.
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