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The world of investing and trading is filled with various strategies and techniques that can potentially bring in profits for traders. One such strategy that has been gaining popularity in recent years is selling naked call options. This approach, also known as writing uncovered calls, is a type of options trading that involves selling call options without owning the underlying stock. But what exactly are naked call options? How do they work? And what are the pros and cons of this strategy? In this article, we will delve into the mysteries surrounding selling naked call options and uncover the secrets behind this intriguing trading technique.
The Origins of Naked Call Options
To understand the origins of naked call options, we must first take a trip back in time to ancient civilizations. In ancient Greece, there was a legend about a wealthy merchant named Thales of Miletus who made a fortune by predicting a good olive harvest. Thales believed that the olive harvest would be plentiful and therefore bought the rights to use all the olive presses in Miletus and Chios. When the harvest was indeed abundant, he was able to rent out the presses at a higher price, earning a huge profit.
This legend is said to be the earliest recorded instance of a naked call option. Thales essentially sold the right to use the olive presses without actually owning them, much like how selling naked call options involves selling the right to buy a stock without owning it. From this ancient tale,...
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we can see how the concept of selling naked call options has been around for centuries, albeit in a different form.
How Naked Call Options Work
Now that we have an understanding of the origins of naked call options, let’s take a closer look at how they work in modern times. In options trading, there are two types of options: calls and puts. A call option gives the buyer the right to buy a stock at a specified price (known as the strike price) within a certain time frame (known as the expiration date). On the other hand, a put option gives the buyer the right to sell a stock at a specified price within a certain time frame.
When selling naked call options, the trader sells call options without owning the underlying stock. This means that if the buyer exercises the option, the trader will have to buy the stock at the market price and sell it to the buyer at the strike price. This strategy is usually used when the trader believes that the stock’s price will not increase significantly, allowing them to keep the premium (the price of the option) as profit.
For example, let’s say a trader sells a naked call option for Company X with a strike price of $50 and a premium of $2. If the stock’s price remains below $50 until the expiration date, the trader keeps the $2 premium as profit. However, if the stock’s price rises above $50, the buyer will exercise the option and the trader will have to buy the stock at the market price (let’s say $55) and sell it to the buyer at the strike p...
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