What Are Naked Call Options?
In options trading, there is an effective strategy that is potentially lucrative but also accompanied by a higher degree of risk. This strategy is known as the “naked call option.” And in this comprehensive article, we will focus on naked call options on Bitcoin. We will delve into the intricacies of what a naked call option on Bitcoin is, the strategies involved, and the risks and rewards associated with it.
What Is a Naked Call?
A naked call on Bitcoin is an options strategy where a trader writes, or sells, call options without owning the underlying Bitcoin. This strategy is considered highly speculative and risky because the investor is exposed to potentially unlimited losses if the price of Bitcoin increases significantly.
Key Takeaways
- A naked call on Bitcoin is an options strategy in which an investor writes call options without owning the underlying Bitcoin;
- This strategy is highly speculative and risky, with boundless losses;
- Gaining a thorough understanding of naked calls on Bitcoin is crucial before engaging in this strategy.
Understanding Naked Calls
A naked call option on Bitcoin, also known as an uncovered call option, is a financial instrument that allows an investor to profit from a stagnant or declining Bitcoin price. When an investor writes a naked call on Bitcoin, they collect a premium from the buyer of the option. If the Bitcoin price remains below the strike price of the option, the seller can keep the premium as profit.
The income received for selling the option may seem attractive at first glance. However, as a seller of a naked call option on Bitcoin, you take the obligation to sell Bitcoin at the exercise price if the option buyer chooses to exercise the option. That is why if the Bitcoin price rises above the exercise price, you may incur significant losses.
How Do Naked Calls Work?
To grasp the concept of naked calls on Bitcoin fully, it is essential to understand the process of writing and closing out a naked call option on Bitcoin.
Writing a Naked Call
To initiate a naked call position, a trader writes (sells) a call option without owning the base asset. In this case, the investor is required to maintain a margin account, which can lead to additional costs and interest charges, adding to the risks associated with this type of options trading. The investor collects the option premium upfront, hoping that the option will expire worthless, allowing them to keep the entire premium as profit.
One key factor to consider when trading naked calls is delta decay. Delta decay refers to the decrease in an option's delta as it approaches expiration, making it less sensitive to changes in the underlying asset's price. This decay can work in favor of the naked call writer, as it increases the likelihood of the option expiring worthless, allowing the market participant to retain the premium. However, it is crucial to understand the risks involved, such as the potential for unlimited losses if the base asset's price rises significantly.
Closing Out a Naked Call
An investor can close out a naked call position on Bitcoin by buying back the call option they sold, ideally at a lower price than they initially sold it for. This allows the investor to keep the difference between the premium they collected and the cost of buying back the option as profit. If the Bitcoin price has increased significantly, however, the cost of buying back the option may be considerably higher, resulting in a loss for the market participant.
It is crucial for investors to monitor their naked call positions on Bitcoin closely and have a plan in place for managing risk. This may involve setting stop-loss orders or using other strategies, such as buying protective puts, to limit possible losses.
Naked Call Example
Let's delve into a hypothetical example to illustrate how a naked call on Bitcoin works. Suppose a market participant writes a naked call option on Bitcoin with a strike price of $22,000 and an expiry date one month away, while the current price of Bitcoin is $20,000.
The investor collects a premium of $500 for writing the call option.
If, at expiration, the Bitcoin price remains below $22,000, the option will expire worthless, and the investor keeps the $500 premium as profit. However, if the Bitcoin price rises to $25,000, the investor will be obligated to deliver Bitcoin at $22,000, incurring a loss of $2,500 per Bitcoin ($25,000 – $22,000 – $500). In more extreme cases, if the Bitcoin price were to skyrocket to $40,000, the trader would incur a substantial loss of $17,500 per Bitcoin ($40,000 – $22,000 – $500).
What Are Uncovered Options?
An uncovered option is just another name for a naked option. That is, it is an option sold by the investor without holding the underlying cryptocurrency or another offsetting position. Investors can open positions with both uncovered call options and uncovered put options on Bitcoin.
What Is an Uncovered Call Option?
An uncovered call option on Bitcoin, or naked call, is a position where an investor writes a call option without owning the base Bitcoin. Uncovered call writing strategy is considered highly speculative and carries potentially unlimited losses if the Bitcoin price increases significantly.
What Is an Uncovered Put Option?
On the other hand, an uncovered put option on Bitcoin, a naked put, occurs when an investor writes a put option without holding the base Bitcoin. This strategy is also considered speculative, with the trader exposed to losses if the Bitcoin price declines significantly.
Obligations of Writers of Naked Call Options
The primary obligation of a naked call writer on Bitcoin is to deliver the underlying Bitcoin if the option is exercised. The writer must purchase Bitcoin at the current market price and sell it at the strike price. However, most cryptocurrency exchanges allow cash settlement of contracts without the delivery of the base crypto asset.
Obligations of Seller of a Naked Put Option
By contrast, the naked put writer is obliged to sell Bitcoin at the strike price if the buyer opts to exercise the option. To do that, the writer would have to purchase the asset first.
How Risky Are Naked Options?
Naked options on Bitcoin, both calls and puts, are considered among the riskiest strategies in options trading. The risk of a naked call on Bitcoin is theoretically unlimited, as there is no cap on how high the Bitcoin price can rise. The risk of a naked put on Bitcoin is limited to the Bitcoin price falling to zero, but this can still result in substantial losses.
Trading naked options requires maintaining a margin account, which can lead to additional costs and interest charges.
To mitigate these risks, investors must be diligent in monitoring their positions and have a well-thought-out risk management plan in place. Additionally, market participants should ensure they have a solid understanding of the Bitcoin market and its possible price movements.
Risks and Rewards
Naked options on Bitcoin, both calls and puts, are considered among the riskiest strategies in options trading. The risk of a naked call on Bitcoin is theoretically unlimited, as there is no cap on how high the Bitcoin price can rise. The risk of a naked put on Bitcoin is limited to the Bitcoin price falling to zero, but this can still result in substantial losses.
Trading naked options requires maintaining a margin account, which can lead to additional costs and interest charges.
To mitigate these risks, investors must be diligent in monitoring their positions and have a well-thought-out risk management plan in place. Additionally, market participants should ensure they have a solid understanding of the Bitcoin market and its possible price movements.
Risks and Rewards
| Pros | Cons |
|---|---|
| Immediate income | Unlimited loss potential |
Profit from market movements without owning the underlying asset |
Margin requirements |
| Opportunity to earn income with low volatility | Limited reward potential |
Why Do Investors Write Naked Option Contracts?
Investors write naked option contracts on Bitcoin for various reasons, including:
- Income generation. By selling naked options on Bitcoin, investors can collect premiums, which can serve as a source of income that can be used or reinvested.
- Speculation. Investors who have a strong directional view on the Bitcoin market may use naked options to speculate on its price movement. This can be particularly enticing for those who believe that Bitcoin's price will remain relatively stable or move in their favor.
- Portfolio management. In some cases, investors may use naked options on Bitcoin to manage risk or enhance the performance of their overall portfolio. For instance, a market participant who has a large position in Bitcoin may write naked calls against it, ensuring a hedge against potential price declines.
Naked Call Alternatives
For investors who find the risks of naked calls on Bitcoin too high, there are alternative strategies that can be employed, such as:
- Covered calls on Bitcoin. In a covered call strategy, the trader owns the underlying Bitcoin and sells call options against it. This way, the investor's risk is offset by the ownership of the Bitcoin. While the possible gains are also capped, this strategy provides a more controlled risk profile compared to naked calls on Bitcoin.
- Vertical spreads on Bitcoin. A vertical spread involves buying and selling two options of the same type (calls or puts) with the same expiry date but different strike prices. This strategy caps both potential gains and losses, providing a more controlled risk profile. Vertical spreads on Bitcoin can be tailored to match an investor's market outlook and risk tolerance, making them a versatile alternative to naked calls on Bitcoin.
- Collars on Bitcoin. A collar strategy involves holding a long position in the base Bitcoin, selling a call option, and buying a put option with the same expiration date. This strategy provides downside protection through the put option while limiting potential gains through the call option. Collars on Bitcoin can be particularly useful for traders who are looking to protect their Bitcoin positions from significant declines while still generating income from option premiums.
The Bottom Line
Naked call options on Bitcoin are a high-risk, speculative strategy that can offer attractive rewards but also carry the potential for significant losses. Understanding the mechanics of naked calls on Bitcoin, as well as the risks and rewards, is crucial before engaging in this type of trading. For those who find the risks too high, there are alternative strategies, such as covered calls, vertical spreads, and collars, that can provide a more controlled risk profile.
As with any investment strategy, it's essential to conduct thorough research and carefully consider your risk tolerance before diving into the world of naked call options on Bitcoin. By taking the time to understand the intricacies of these strategies and their potential implications, you can make more informed decisions and navigate the options trading on Bitcoin with greater confidence.
*This communication is intended as strictly informational, and nothing herein constitutes an offer or a recommendation to buy, sell, or retain any specific product, security or investment, or to utilise or refrain from utilising any particular service. The use of the products and services referred to herein may be subject to certain limitations in specific jurisdictions. This communication does not constitute and shall under no circumstances be deemed to constitute investment advice. This communication is not intended to constitute a public offering of securities within the meaning of any applicable legislation.
