InvestorQ : What are Covered call options and naked call options and when to use them?
Bhavik Nehru made post

What are Covered call options and naked call options and when to use them?

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Bhavik Nehru answered.
3 years ago
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A call option position that is covered by an opposite position in the underlying instrument (for example shares, commodities etc), is called a covered call. Writing covered calls involves writing call options when the shares that might have to be delivered (if option holder exercises his right to buy), are already owned. For example, a writer writes a call on Reliance and at the same time holds shares of Reliance so that if the call is exercised by the buyer, he can deliver the stock. Let us take an example. If you are holding on to Reliance shares purchased at Rs.1150 and then you can earn some premium by selling an Rs.1200 call option. As long as the stock of Reliance expires below Rs.1200 you earn the premium on the call option. If the stock of Reliance goes above the Rs.1200 mark, then the loss on the short call option will be compensated by the appreciation in the stock price. That is why it is called a covered call position. Naked calls in the above case are a case of just selling the Rs.1200 Reliance call option. Covered calls are far less risky than naked calls (where there is no opposite position in the underlying); since the worst that can happen is that the investor is required to sell shares already owned at below their market value. When a physical delivery uncovered/ naked call is assigned on exercise, the writer will have to purchase the underlying asset to meet his call obligation and his loss will be the excess of the purchase price over the exercise price of the call reduced by the premium received for writing the call. In the above case, if the trader has sold a naked call option on RIL at Rs.1200 and the price of the RIL goes up to Rs.1280, then the entire loss of Rs.80 has to be taken by the trader. Naked options are for purely trading purposes while covered calls are more for hedging purposes.
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