Naked Call: Overview, Uses, Example, Factors, Strategies, Risks
A naked call is an options strategy where a trader sells a call option without owning the underlying asset, exposing them to unlimited risk if prices rise sharply. Naked call is categorised into two – naked long call (buying a call without hedge) and naked short call (selling a call without owning the asset).
Traders use naked calls for premium income in bearish or neutral markets, benefiting from time decay. However, factors like delta, theta, vega, and margin requirements impact risk and profitability.
Common strategies include selling out-of-the-money (OTM) calls, combining naked calls with short puts, and hedging with options spreads. Naked calls carry significant risks, including unlimited loss potential, high capital requirements, and exposure to volatility.
Compared to covered calls (which involve stock ownership), naked calls are riskier. Safer alternatives include covered calls, bear call spreads, and protective puts. This strategy suits only experienced traders with strong risk management.
What Exactly is a Naked Call?
Naked call is an options strategy where an investor sells a call option without owning the underlying asset. Naked call exposes the seller to unlimited risk because if the price of the underlying asset rises very much above the strike price, the seller must purchase it at the higher market price to fulfill the contract, leading to potentially infinite losses. The profit potential, however, is limited to the premium received when the option is sold.
Naked call is considered high-risk because there is no cap on how much the underlying asset’s price increases. This strategy also requires margin requirements from brokers, tying up capital and increasing financial pressure in adverse market conditions. Due to its complexity and risk, naked calls are typically used only by experienced traders with a bearish outlook on the asset.
How Does a Naked Call Work?
There are two types of naked calls – naked long call or buying a naked call or naked short call or writing a naked call.
1. Naked Long Call
Naked call buying or long naked call is carried out by traders who speculate on an asset’s price rising over a short period, often intraday. As seen in the payoff chart below, an in-the-money call option has been bought nakedly. See the image below.
The flat red line represents the limited downside, indicating a 100% loss potential.
- The current market price of Nifty is ₹23,750.
- The trader has invested ₹50,000 in a naked call (strike price ₹23,700) at a premium of ₹245.
- For the position to break even, Nifty must cross ₹23,950.
- For this trade to become profitable, Nifty 50 must rise above ₹23,950 (200 points above the CMP) by expiry.
Incase of Nifty remains flat or bearish, the entire ₹50,000 investment could be wiped out, as naked call buying involves 100% premium erosion if the speculation is incorrect. This is the biggest drawback of option buying.
The key advantage of trading naked call options, which is closely related to the Short Call strategy, is their theoretically unlimited profit potential for the seller — and unlimited loss risk if not managed properly. In contrast, a Long Call offers unlimited profit potential for the buyer with limited risk. Additionally, skilled traders who can scalp small price movements effectively may generate consistent profits if risk is managed meticulously.
2. Naked Short Call
A naked short call, also known as writing a naked call, is an options trading strategy where a trader sells a call option without owning the underlying asset. Let us understand this through an example.
The option trader has sold a 24000 CE contract at a premium of ₹97.85.
It is assumed by the trader that the 24000 strike price will stay protected for at least 7 days, as the contract is set to expire in 7 days from the day of this example.
If Nifty rises slowly, the trader may not face much of an issue. However, if Nifty 50 rises sharply and rapidly, the premium of the 24000 call option can increase quickly. In such a scenario, if the speculation goes wrong, it becomes difficult to adjust the position.
In these cases, a hedged position can help minimize potential losses. For this position to remain profitable, Nifty 50 must close below 24000 at expiry.
Why Use a Naked Call Strategy?
You should use a naked call strategy as it provides potential benefits, particularly for experienced traders with a bearish or neutral market outlook.
One of the primary advantages of selling naked calls is the immediate income generated from premiums. When traders sell call options without owning the underlying asset, they collect a premium upfront, which becomes profit if the option expires worthless. This is an effective way to generate cash flow in a stagnant or declining market
Naked calls allow traders to profit from their bearish predictions without needing to short-sell the underlying asset. If the stock price remains below the strike price at expiration, the seller keeps the premium without further obligations. This strategy leverages time decay (theta), as options lose value as they approach expiration, benefiting the seller if prices stay stable or decline.
Also, naked calls require less capital than strategies involving ownership of the underlying asset, offering flexibility for traders to act on their market outlooks without tying up significant funds. However, due to its high-risk nature and unlimited loss potential, this strategy is best suited for seasoned traders with robust risk management practices.
When to Trade Naked Call?
Occasions to trade naked calls include scenarios where traders anticipate bearish market sentiment, high implied volatility, or opportunities with near-term expiration options.
In bearish markets, traders use naked calls when they expect the underlying asset’s price to decline or remain stagnant. This allows them to profit from the premium received upfront as the option becomes worthless at expiration.
High implied volatility also makes naked calls attractive because it increases the premium received. However, traders must carefully manage risks since high volatility also raises the likelihood of significant price swings that could lead to losses.
For near-term expiration options, time decay works in favor of the seller. As expiration approaches, options lose value rapidly if they remain out-of-the-money, allowing traders to capitalize on this accelerated decline.
Due to the inherent risks of unlimited losses, naked calls are best suited for experienced traders with a disciplined risk management approach.
What are the Factors to Consider Before Selling Naked Calls?
Before selling naked calls, traders must consider critical factors to manage risks and optimize potential returns. These factors include the option Greeks—Delta, Theta, and Vega—as well as margin requirements.
- Delta (Price Sensitivity): Delta measures how sensitive an option’s price is to changes in the underlying asset’s price. For naked calls, a higher delta indicates greater sensitivity, meaning the option’s price will increase significantly if the stock rises, leading to potential losses. As expiration approaches, delta for in-the-money options increases rapidly, amplifying risk. Traders should monitor delta closely to gauge directional exposure and adjust positions accordingly.
- Theta (Time Decay): Theta represents the rate at which an option loses value as time passes. For naked call sellers, time decay works in their favor since the option’s value decreases as expiration nears, provided the stock remains below the strike price. However, higher implied volatility slow down theta decay, so traders must assess volatility levels before entering a trade.
- Vega (Volatility Impact): Vega measures how an option’s price changes with shifts in implied volatility. Higher volatility increases the premium received but also raises the risk of significant price swings that could move the stock above the strike price. Conversely, lower volatility reduces premiums but decreases risk. Traders should evaluate market conditions and implied volatility trends before selling naked calls.
- Margin Requirements: Selling naked calls requires substantial margin due to the unlimited loss potential. Brokers calculate margin based on factors like the underlying asset’s value and option premium. Typically, margin requirements are set at 10-20% of the stock’s value plus the premium received. Traders must ensure they have sufficient capital to cover potential losses and avoid margin calls.
Carefully analyzing these factors helps make informed decisions about whether selling naked calls aligns with their risk tolerance and market outlook.
What are the Top Naked Call Strategies?
Selling OTM calls, naked calls with short puts, and hedging with naked calls are three top naked call strategies.
1. Selling OTM Calls
Selling OTM Calls means selling a call option that is currently “out of the money,” which means the strike price of the call option is higher than the current market price of the underlying asset, essentially allowing you to collect a premium from the buyer of the option while having a limited potential loss if the stock price does not rise significantly before the option expires.
Consider a scenario where a trader sells out-of-the-money (OTM) call options.
- The current market price of Nifty 50 is ₹23,155.
- The nearest expiry is due the next day.
- The trader speculates that Nifty 50 will stay flat or bearish and will close below ₹23,400 at expiry.
Based on this assumption, the trader aims to collect premiums by selling OTM call options at strike prices of ₹23,400, ₹23,450, and ₹23,500, believing these levels will hold for at least one day. The trade will be profitable only if Nifty 50 closes below ₹23,427.
- Nifty 50 stays below ₹23,400, the trader keeps the entire premium as profit.
- Nifty 50 crosses ₹23,400 and rises sharply, the prices of the sold OTM call options will increase, leading to potentially massive losses.
- In such cases, position adjustments and risk management are crucial.
The trader sells 23,400, 23,450, and 23,500 call options, collecting premiums of
- ₹12 for 23,400 CE
- ₹8 for 23,450 CE
- ₹6 for 23,500 CE
Nifty 50 remains below ₹23,400 at expiry, all the sold call options expire worthless, and the trader keeps the full premium as profit.
Since the trader is confident in the ₹23,400 resistance level, they choose to sell multiple OTM strikes to maximize premium collection.
2. Naked Calls with Short Puts
A “naked call with short puts” strategy in options trading refers to selling (writing) a naked call option while simultaneously selling (writing) a put option at a lower strike price, essentially creating a bearish outlook on the underlying security, aiming to profit from the premium received by selling both options, but with significant risk due to the potential for large losses if the stock price falls significantly below the put strike price.
Let us take an example to understand this.
In this scenario, the underlying asset is Nifty 50, with the nearest monthly expiry in 4 days. The option seller expects the market to either continue its bearish trend or consolidate before expiry. The trader has identified ₹23,200 as a strong resistance level and is confident that Nifty 50 will close below ₹23,250. Based on this conviction, the trader sets up the following options positions.
First, the trader sells a 23,250 call option at ₹45, expecting Nifty 50 to remain below this level. Since this is a naked call sell, it carries unlimited risk if the market moves sharply upward. However, the trade remains profitable as long as Nifty closes below ₹23,250 at expiry.
To take advantage of a possible flat or slightly bearish market, the trader also sells a 22,450 put option at ₹40. Since they are uncertain about the support level, they choose to hedge their downside risk by buying a 22,350 put option at ₹30. This hedge ensures that if Nifty 50 falls sharply, losses on the short put are limited.
By executing this strategy, the trader collects a total premium of ₹55—₹45 from the short call and ₹10 from the hedged put position (₹40 from short put minus ₹30 from the long put hedge). The breakeven price for this trade is ₹23,305 (23,250 strike price + ₹55 premium).
If Nifty 50 closes between ₹23,250 and ₹23,305, the trade will be at breakeven. If Nifty 50 closes below ₹23,250, the trader keeps the full premium as profit. However, if Nifty 50 rises above ₹23,305, the position will start incurring losses, requiring risk management adjustments.
Look at the below payoff diagram.
The payoff diagram highlights how the put side is hedged, minimizing the downside risk. However, the call side remains unhedged, meaning the trader is exposed to theoretically unlimited risk if Nifty moves significantly higher. This trade is profitable only if Nifty 50 stays below ₹23,250. If the price crosses ₹23,305, adjustments or stop-loss strategies will be needed to manage potential losses.
3. Hedging with Naked Call
Hedging with a naked call involves strategies to manage the significant risks associated with selling a call option without owning the underlying asset. Here’s an explanation of the concept and how hedging is applied. Take a look at the below chart.
For this example, the selected stock is Tech Mahindra Ltd, which is currently under bearish pressure. The nearest monthly expiry is in 4 days, and based on technical analysis, the option seller believes the stock price will stay below ₹1,700.
To capitalize on this conviction, the seller has sold the ₹1,700 call option at ₹7. If the stock price closes below ₹1,700 at expiry, the seller will collect ₹7 per lot as profit. However, since this is a naked call, it carries unlimited risk if the stock price rises sharply.
To reduce the risk, the seller buys a cheaper hedge—₹1,740 call option at ₹2. This creates a credit spread, where the potential profit is reduced but risk is minimized. The breakeven level for this position is ₹1,705 (strike price of ₹1,700 + net premium of ₹5). If the stock price stays below ₹1,700, the seller will retain the premium as profit. However, if the stock crosses ₹1,705, the position will start to incur losses.
What are the Risks of Naked Call?
The risks of selling naked calls are substantial and include the following.
- Unlimited Loss Potential: The most significant risk of a naked call is the unlimited loss potential. If the price of the underlying asset rises significantly above the strike price, the seller must purchase the asset at the higher market price to fulfill the contract, leading to theoretically infinite losses.
- High Capital Requirements: Brokers impose substantial margin requirements for naked calls due to their high-risk nature. This ties up a significant portion of the trader’s capital and can lead to margin calls if the position moves unfavorably, forcing liquidation at potentially unfavorable prices.
- High Volatility Exposure: Naked call sellers are highly exposed to market volatility. While high implied volatility increases premiums, it also raises the likelihood of sharp price movements that result in significant losses if the stock price surges unexpectedly.
These risks make naked calls suitable only for experienced traders with strong risk management practices.
What is the Difference Between Naked Call & Covered Call?
The main difference between a naked call and a covered call is ownership of the underlying asset. In a naked call, the seller does not own the underlying asset, exposing them to unlimited risk if the asset’s price rises significantly.
In contrast, a covered call involves selling a call option while owning the underlying asset, which limits risk because the seller delivers the asset if exercised. Covered calls are generally considered less risky and are often used for income generation in neutral or slightly bullish markets.
Naked calls, on the other hand, are riskier and suited for experienced traders with bearish outlooks.
What is the Difference Between Naked Call & Naked Put?
The difference between a naked call and a naked put lies in their market direction and risk exposure. A naked call is sold when the trader expects the underlying asset’s price to remain flat or decline, with unlimited loss potential if prices rise.
A naked put is sold when the trader expects prices to remain flat or increase, with losses limited to the strike price minus the premium received if prices fall sharply.
Both strategies involve significant risk but differ in their directional bias—naked calls are bearish, while naked puts are bullish. Both require substantial margin due to their high-risk nature.
Is Selling Naked Calls Profitable?
Yes, selling naked calls is profitable under specific conditions but carries risks. Profitability arises when the underlying asset’s price remains below the strike price at expiration, allowing the seller to keep the premium received.
However, unexpected price increases result in unlimited losses, making this strategy highly risky. It is most effective in stable or bearish markets with low volatility but requires precise market predictions and strong risk management.
While potentially lucrative, it is not suitable for inexperienced traders due to its high-risk profile.
What are Alternatives to Naked Calls?
Alternatives to naked calls include strategies that limit risk while still generating income or leveraging bearish market views. Covered calls offer a safer option by combining stock ownership with call selling to cap potential losses. Bear call spreads involve selling a call option and buying another at a higher strike price, limiting both risk and reward.
Traders also consider protective puts or cash-secured puts for more controlled exposure. These alternatives provide structured risk management compared to the unlimited loss potential of naked calls.
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