Naked Option

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Definition of 'Naked Option'

A naked option is a risky options trading strategy in which an investor sells an option without owning the underlying security.

In options trading, an option is a contract that gives the buyer the right, but not the obligation, to buy or sell the underlying security at a specified price (strike price) within a certain time frame. When an investor sells an option, they receive a premium from the buyer, and in exchange, they must be prepared to sell (in the case of a call option) or buy (in the case of a put option) the underlying security if the buyer decides to exercise the option.

In a naked option strategy, the investor sells the option without owning the underlying security. This means that if the buyer decides to exercise the option, the seller must purchase (in the case of a call option) or sell (in the case of a put option) the underlying security in order to fulfill the option contract. If the market price of the security has moved significantly against the seller, the losses for the investor can be substantial.

Naked option strategies are considered to be very risky because they have unlimited potential losses. If the market price of the underlying security moves significantly against the investor, the losses can be much larger than the premium received. For this reason, naked option strategies are generally only used by experienced traders who are willing to accept the high level of risk involved.

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