Naked Call Option Calculator

Suppose you are an options trader and believe that XYZ Corporation's stock, which is currently trading at $50 per share, will decline in value over the next few weeks. You decide to sell a naked call option.

Step 1:  Choose the Option Contract

You select a call option contract with the following details:

Strike Price:  $55
Price Per Option:  $3
Number of Contracts:   2

Step 2:  Determine Your Maximum Profit

The maximum profit for selling a naked call option is the total premium you receive:

Max Point =  Price Per Option x Number of Contracts x 100
Breakeven Point =  $3 x 2 x 100
Breakeven Point =  $600

Step 3:  Calculate Your Breakeven Point

To calculate the breakeven point, add the strike price to the premium received:

Breakeven Point =  Strike Price + Option Premium
Breakeven Point =  $55 + $3
Breakeven Point =  $58 per share

This means that the stock's price must stay below $58 per share for you to make a profit. If the stock's price goes above $58, your losses start to accumulate.

Step 4:  Determine Your Maximum Loss

The maximum loss for selling a naked call option is theoretically unlimited because there's no upper limit to how high the stock's price can rise. Your loss increases as the stock price rises above the strike price.

Step 5:  Monitor the Trade

Keep a close eye on the stock's price movement. If it remains below the strike price of $55, you can potentially keep the entire premium as your profit. If the stock's price rises above the strike price, your losses will increase as the price moves higher.

Step 6:  Decide When to Close the Position

You should have a plan for when to close the naked call option position. If the stock's price starts rising and you begin to incur significant losses, you may want to consider buying back the call option to limit your potential losses. Alternatively, you can wait until expiration if the stock price remains below the strike price.

Step 7:  Closing the Position

Suppose the stock's price indeed declines, and you decide to close the position before expiration. To do this, you would buy back the same call option contract you initially sold. The cost to buy it back will depend on the current market price of the option. If the option price has fallen, you might be able to buy it back at a lower price, resulting in a profit.

Benifits of Naked Call Options

Income Generation:   Naked call options can generate immediate income through the premiums received when selling the contracts. This income is yours to keep, regardless of the option's outcome.

High Probability of Profit:   This strategy profits when the underlying asset's price remains below the strike price. If the stock doesn't rise above the strike, the option expires worthless, allowing you to keep the premium.

Hedging Strategy:   Some traders use naked calls as a hedging tool, especially when they believe a stock is overvalued. If the stock's price falls, the premium from the call option can offset potential losses.

Risks of Naked Call Options

Unlimited Risk:   One of the most significant drawbacks of trading naked call options is the unlimited potential for loss. If the underlying asset's price rises significantly, your losses can be substantial as you're obligated to sell the asset at the strike price, potentially at a substantial loss.

Margin Requirements:   Brokerages typically require substantial margin deposits for naked call options due to the unlimited risk. This ties up your capital and can limit other trading opportunities.

Limited Profit Potential:   The profit potential in naked call options is capped at the premium received. In contrast, the potential for loss is unlimited, making the risk-reward ratio unfavorable.

Timing and Direction:   Naked calls depend on correctly predicting the direction and timing of the underlying asset's price movement. If the stock rises unexpectedly or experiences a significant price gap, you may face substantial losses.

In summary, trading naked call options can provide immediate income and serve as a hedging strategy, but it comes with significant risks, including unlimited potential losses and high margin requirements. It should only be considered by experienced traders who understand the risks and have a well-thought-out risk management strategy in place.