Question

Explain the differences between trading Naked call and puts and Covered calls and puts, why does this matter and what differences does it mean in margin management and risk management? Be specific and detailed.

Answer 1

Naked position means playing in option market/future market with out hedging. When investor buys only call option or buys only put option without having holding of underlying security than such position is known as naked position. It is extremely risky. If an event occur which is different than originally expected than the losses might be unlimited in future market or for seller of call or put option.

As Against this Cover called and cover put are used to mitigate loss. In cover called a call is purchased at lower strike price and a call is sold at higher strike price thus reducing amount of premium to be paid in other words loss. Similarly in covered put a put option with higher strike price is bought and put option with lower strike price is sold. This kind of strategies helps one to reduce losses if their prediction goes wrong