Selling naked calls is one of the riskiest strategies of all. The potential loss is unlimited.
Unlike covered calls, where the option seller owns the underlying stock, the writer of naked calls remains completely exposed to upside risk. Nevertheless, if you are comfortable using this strategy, it is most effective using near term options because they decay more rapidly. And that's what you want. The faster these options become worthless, the better.
Example
Let's look at International Business Machines (IBM); trading at $83.10. By selling the 90 call for $1.35, you would receive the $135 option premium, your maximum profit. At expiration, if the stock is at or below 90, you keep the full $135. However, your profit disappears as the stock climbs toward $93. Above $93, your loss grows without limit.
| IBM trading @ $83.10 |
| Sell |
Jun 90 Call @ $1.35 |
($135) |
| Credit from Trade |
($135) |
Given the mounting losses apparent in the table below, it should be clear that naked call writing is an extremely risky strategy. Even the most bearish investor would do well to convert this position to a bear spread by buying an out-of-the money call. This would limit upside losses.
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