Uncovered Option

Search Dictionary

Definition of 'Uncovered Option'

An uncovered option is a financial contract in which the writer does not have the underlying asset. This means that if the option is exercised, the writer must purchase the underlying asset at the strike price.

Uncovered options are considered to be riskier than covered options, because the writer is exposed to the risk of the underlying asset increasing in value. If the underlying asset increases in value, the writer will have to purchase the asset at a higher price than they sold it for.

There are two main types of uncovered options: naked calls and naked puts. A naked call is an option to buy a stock that the writer does not own. A naked put is an option to sell a stock that the writer does not own.

Naked calls are considered to be riskier than naked puts, because the maximum loss on a naked call is theoretically unlimited. If the underlying asset increases in value to infinity, the writer will have to purchase the asset at a price that is higher than infinity.

Naked puts are considered to be less risky than naked calls, because the maximum loss on a naked put is the strike price of the option. If the underlying asset decreases in value to zero, the writer will only have to sell the asset at the strike price.

Uncovered options are often used by traders who are speculating on the direction of the underlying asset. Traders who believe that the underlying asset will increase in value will sell naked calls. Traders who believe that the underlying asset will decrease in value will sell naked puts.

It is important to note that uncovered options are not for the faint of heart. They are a risky investment that can lead to significant losses. Only experienced traders should consider trading uncovered options.

Do you have a trading or investing definition for our dictionary? Click the Create Definition link to add your own definition. You will earn 150 bonus reputation points for each definition that is accepted.

Is this definition wrong? Let us know by posting to the forum and we will correct it.