An investor who writes a call option without owning the underlying stock is banking on a flat to bearish short-term forecast for the stock. The strategy consists of writing the call in hopes that it will lose value through time decay and eventually expire out-of-the-money. If the term ends without the option being assigned, the writer keeps the entire premium initially received, and all obligations under the short call position terminate.
The strategy’s staggering risk stems from the investor’s obligations should the stock unexpectedly rally and the call be assigned. The naked call writer has no way to offset assignment risk. To make matters worse, the obligation is open-ended. Since there is no limit to how high the stock’s price could rise, there is no upper boundary to the losses to be incurred in acquiring the stock for delivery in the event of assignment. Choosing higher strike prices and shorter expiration terms could make the strategy somewhat less dangerous, but there is simply no way to predictably counter the huge risk.
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