A naked option is when the investor does not have any other position in the security either in cash, or futures and options.
Naked options positions are for those investor who have a high risk appetite and are very sure about the direction of the market.
When to use this strategy?
This strategy is used when the investor is bullish and thinks that the price of the underlying security will not fall below a certain level.
How to build this strategy?
This strategy comprises of only one leg:
Leg 1 – Sell 1 OTM/ATM/ITM Put
Credit Spread/Debit Spread
Selling of naked options is always a credit transaction as the investor receives a premium for selling the option.
This strategy has limited profit potential.
The profit is limited to the net premium received.
When is this strategy profitable?
The investor earns a profit if the price of the underlying security remains above the strike price of the call option.
The investor faces unlimited risk in this strategy.
When is this strategy unprofitable?
The investor will have to bear large losses incase the underlying security price falls drastically.