Sunday, September 25, 2011

Naked Option

A Naked Option is an option that is not combined with an offsetting position in the underlying stock. It is more risky and profitable then the clothed or covered option.

Since the traders don't need to hold the underlying asset, they don't need to spend money to acquire the assets or stocks. The writer could short more call option or put option than the original ones. Say call option. If the current stock price goes down, the intrinsic value of the option is zero, and the writers could earn the commission in this case. They could make more money by selling more contracts in this way. However, if the current price goes into an opposite way, they would lose lots of money because there is no limitation while they short the contracts. Although it might be more profitable, it is definitely more risky.

CBOE has make an colleteral requirement to ask traders to have margin account which is calculated daily:
Naked call: Greater of:
1. 100%proceeds+ 20% (15% for stock index)* of underlying- Amount OTM
2. 100%proceeds+ 10% of underlying
Naked put: Greater of:
1. 100%proceeds+ 20%(15% for stock index) of underlying- Amount OTM
2. 100%proceeds+ 10% of underlying

* Because stock index (regarded as portfolio) is less volatile than the price of an individual stock.