Loading...

(/ksweb/) Account Login (/ksweb/php/login.php)

Trade Now (/ksweb/php/login.php) About Us Offerings Markets Research Help Partner With Us ()

Get Quote

RESEARCH: Knowledge Bank

Meaningful Minutes (/ksweb/Research/Knowledge-Bank/Meaningful-Minutes)

Stock Trader App (/ksweb/Our-Offerings/Trading-Tools/Kotak-Stock-Trader-App)

Demat Account (/ksweb/Our-Offerings/Account-Types/Demat-Account)

Chapter 2.8: Understanding Covered & Naked Options

Contracts OPEN SHARE
TRADING
What are derivative contracts without the underlying assets? Nothing. ACCOUNT
So, does this mean that only traders who already own the underlying assets can trade in the market? No. You can trade even if you don’t NOW
actually own the underlying shares.
This is where we come to covered and naked options.
Full Name

WHAT ARE COVERED AND NAKED OPTIONS? 10 Digit Mobile No.

Simply put, covered options are contracts sold by traders who actually own the underlying shares. In contrast, naked options are those
E-mail Address
where the writer does not own the underlying assets. Writers of naked options are thus unprotected or ‘naked’ from an unlimited loss.

Mumbai ▼

COVERED OPTIONS V/S NAKED OPTIONS

SUBMIT

Note

WHY CAPITAL GAINS

REPORT?
Snapshot of profit/loss

Reflects performance of your

portfolio
Helps compute taxes

WHY CHOSE COVERED OPTIONS?

In the earlier sections, we understood the profit-loss potential of options for buyers and sellers. The buyers are not actually obligated to
exercise the agreement. So, they have limited scope for losses, as they are only subject to lose the amount they paid as premium. Sellers,
on the other hand, are obligated to uphold the contract if and when the buyer chooses. This increases his potential liability. Also, the seller’s
profit is largely limited to the premium he/she receives.

So, does this mean that an option seller must necessarily be a risk-taking speculator? Not really.

You could sell call options in order to reduce the cost of your investments or hedge your investments. The only requirement is that you must
actually hold the underlying shares of the calls that you sell.

For example, IT companies benefit from an undervalued rupee as they earn money in dollars. On the other hand, importers benefit from a
strong rupee as they spend in dollars. Thus, what is suitable to one investor may not be so for another.

Thus, covered options are largely opted by hedgers and risk-evaders. They are traders who are looking to safeguard their assets –
predominantly currencies – from future fluctuations. They, thus, aim to transfer their risk.

Read about Options

Trading
 (http://www.slideshare.net/KotakSecurities/no-
you-dont-have-to-learn-greek-to-
understand-options-trading)
Read More >
(http://www.slideshare.net/KotakSecurities/no-
you-dont-have-to-learn-greek-to-
understand-options-trading)

COVERED OPTIONS V/S NAKED OPTIONS

WHY CHOSE NAKED OPTIONS?

When you sell a naked call or put option, you have no underlying assets or open position in the futures market to protect you from an
unlimited loss, if the market goes against you. However, this does not necessarily mean that a naked option does not have its perks. It
allows traders to participate in the derivatives market even if they have relatively small holdings in the cash segment.

Naked options are usually sold by speculators, who feel very strongly about the direction of an index or the price of a stock. And, if the
market does go against them, they may try to salvage the situation by offsetting their options by purchasing identical but opposing options.
They could also consider taking up a position in the futures market that will nullify the losses made through selling a naked call or put.

HOW TO TRADE WITH COVERED OPTIONS

As we read earlier, covered options are often used by hedgers or those looking to reduce prices of existing shares, while naked options are
predominantly used by speculators. However, this is not necessary. Speculators can also opt for covered options. Here’s a look at how
covered options are traded:

REDUCING THE PRICE OF EXISTING SHARES: SPECULATION:

Suppose you actually hold 600 shares of Reliance in
your demat account. If you do not expect any major
movements in the price of Reliance in the cash market
and wish to reduce the cost of these shares, you could
sell a call option to the extent of the shares that you hold.
This becomes a covered call.
Here's how it works.
If you do not expect the price of Reliance to go beyond
Rs 950 per share, you may sell a Reliance call option at
a strike price of Rs 950 for a premium of Rs 20. You will
receive a total premium of Rs 12,000 (Rs 20 x 600
shares).
A covered call could also benefit a speculator who does
not want to take undue risks, but merely make the most
of a bearish expectation from the price of an underlying
share or index.
Let's say that you expect the price of Reliance to fall.
You could purchase a put option to benefit from this
situation, but that would mean that you have to pay a
premium. So, instead, you may decide to sell a Reliance
call option and receive a premium. Remember, when you
sell a call option, you are actually agreeing to sell to the
call option buyer.
This is the same as buying put option. If the price of
Reliance moves in your favour
 If all goes well and the price does not increase above Rs – i.e. it actually falls, the call will not be exercised.
950, your shares are safe with you and the premium that However, if it rises beyond the strike price, you could use
you receive goes towards reducing the cost of the shares the shares that you hold to settle off the buyer of the call
that you hold by Rs 20 each. However, if the price does option.
go above Rs 950, you always have your shares to fall
back on. You could sell off your shares to settle off the
buyer of the call. It is assumed that you will have chosen
a strike price that is above the cost at which you
purchased the shares.

This helps when the option is exercised, as you do not

make an actual loss. However, you do make a notional
loss. This is because you are not able to benefit from
selling your shares at a price higher than the strike price,
although the market has crossed that level.

You could also use the covered call strategy to limit the
risk of an open position that you have in the futures
market, by likening your long futures position to the long
cash market position explained in the covered call
illustration above.

HOW TO SETTLE COVERED AND NAKED OPTIONS?

Covered options are commonly settled by upholding the agreements and physically selling or buying the underlying assets. Naked options,
on the other hand, could be settled predominantly by squaring off the position.

SQUARING OFF: IGNORE:

Since you do not really own the underlying assets –
shares, in this case – you would need to buy options
which can nullify the trade. However, since you are
actually buying the two options at two different times, the
prices will differ.
Options, unlike futures contracts, is flexible. The buyer is
not under any obligation to actually uphold the terms of
the agreement and sell/buy the underlying asset. For this
reason, you can simply let the option mature without
exercising it.

This is the opportunity to make a profit. However, it could However, if you are the seller, and the option buyer has
also be a loss-making transaction. opted to exercise the option, you cannot ignore it.

You can also square off your open position by selling the In which case, you may have to borrow the underlying
contracts that you previously brought. This way, you are assets or actually buy it from the cash segment and sell
selling your liability. to the option buyer.

WHAT NEXT?

In this section, we understood the basics of Options contracts. In the next part, we go into details about Call options and Put options. Click
here (/ksweb/Research/Investment-knowledge-Bank/difference-between-futures-and-options)

Previous Chapter (/ksweb/Research/Investment-knowledge-Bank/what-are-put-options)

Next Chapter (/ksweb/Research/Investment-knowledge-Bank/difference-between-futures-and-options)

Trading Demos

Mobile Trading with Kotak Stock Trader (https://www.youtube.com/watch?v=akx0Btwsqa4)

View Demo (https://www.youtube.com/watch?v=akx0Btwsqa4)

 Desktop Trading with KEAT ProX (https://www.youtube.com/watch?v=TfT58NB-Sj4 )
View Demo (https://www.youtube.com/watch?v=TfT58NB-Sj4 )

Stock Market Sectors : A (https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/A) | B (https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-

and-NSE/B) | C (https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/C) | D (https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/D)
| E (https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/E) | F (https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/F) | G
(https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/G) | H (https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/H) | I
(https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/I) | J (https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/J) | L
(https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/L) | M (https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/M) | N
(https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/N) | O (https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/O) | P
(https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/P) | R (https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/R) | S
(https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/S) | T (https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/T) | V
(https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/V) | W (https://www.kotaksecurities.com/ksweb/sectors-listed-in-BSE-and-NSE/W) |
About Us Asset Classes Trading Tools & Research Account Types & Value Added Equity Market
Reports Services
• About Kotak Securities (/ksweb/About- • Equity Trading (/ksweb/Our- • Gainer
Us/Why-Choose-Us/About-Kotak- Offerings/Assest-Classes/Easy-Equity) • KEAT PRO X (/ksweb/Our- • Demat Account (/ksweb/Our- (/ksweb/HotMarketCuts/gainers)
Securities) offerings/Trading-Tools/Keat-Pro-X) Offerings/Account-Types/Demat-
• Derivative Trading (/ksweb/Our- • Loser (/ksweb/HotMarketCuts/losers)
• Awards and Accolades (/ksweb/About-Offerings/Asset-Classes/Derivative) • Kotak Stock Trader APP (/ksweb/Our- Account)
• Most Active Stocks
Us/Why-Choose-Us/Awards-and- Offerings/Trading-Tools/Kotak-Stock- • 2 in 1 Account (/ksweb/Our-
• Mutual Fund Investment (/ksweb/Our- (/ksweb/HotMarketCuts/most_active_stocks)
Accolades) Trader-App) Offerings/Account-Types/Two-in-One-
Offerings/Asset-Classes/Easy-Mutual- • Volume Buzzer
• Fastlane (/ksweb/Our- Account)
• About Kotak Group (/ksweb/About- Funds) (/ksweb/HotMarketCuts/volume_buzzer)
Us/Why-Choose-Us/About-Kotak- Offerings/Trading-Tools/Fastlane) • Trinity Account (3-in-1 Account)
• IPO (/ksweb/Our-Offerings/Asset- • 52Wk High
Group) • Xtralite (/ksweb/Our- (/ksweb/Our-Offerings/Account-
Classes/Easy-Ipo)
Offerings/Trading-Tools/Xtralite) Types/Trinity-Online-Trading-Account) (/ksweb/HotMarketCuts/52highweek)
• Technology (/ksweb/About-Us/Why- • Gold Funds (/ksweb/Our- • 52Wk Low
Choose-Us/Technology) Offerings/Asset-Classes/Gold-Funds) • Dealer assisted trading (/ksweb/Our- • Linked Account (/ksweb/Our-
Offerings/Account-Types/Linked- (/ksweb/HotMarketCuts/52lowweek)
• Strong Research (/ksweb/About- Offerings/Trading-Tools/Dealer-
• Currency Derivatives (/ksweb/Our- Account) • All Market News (/ksweb/News/ALL)
Us/Why-Choose-Us/Strong-Research) Offerings/Asset-Classes/Currency- Assisted-Trading)

• Customer Support Chat
(/ksweb/Help/Chat)
• Brokerage Charges (/ksweb/Our-
Offerings/Brokerage-
Options/Brokerage-Charges)
Derivatives)
• Fixed Deposits & Tax Free Bonds
(/ksweb/Our-Offerings/Asset-
Classes/Tax-Saving-Fixed-Deposit-
Bonds)
• Debentures (/ksweb/Our-
Offerings/Asset-Classes/non-
• Call and Trade (/ksweb/Our- • NRI Account (/ksweb/nri- • Bullion News (/ksweb/News/BUL)
Offerings/Trading-Tools/Call-and-Trade) account/open-an-nri-account) • Economy General
• Investors Research • RGESS (/ksweb/Our- (/ksweb/News/EGR)
(/ksweb/Research/Kotak-Research- Offerings/Account-Types/RGESS)
• Corporate Actions (/ksweb/UpResults)
Center/Investors-Research) • PMS (/ksweb/Our-Offerings/Account-
• Other News (/ksweb/News/OTH)
• Trader Research Types/Portfolio-Management-Service)
(/ksweb/Research/Kotak-Research- • Margin Trading (/ksweb/Our-

convertible-debentures) Center/Trader-Research) Offerings/Value-Added-

• Mutual Fund Research Features/Margin-Trading)

Derivatives Market
• Most Active Contracts
(/ksweb/PutCall/activecontracts)
• Gainers (/ksweb/PutCall/gainers)
• Losers (/ksweb/PutCall/losers)
• Top Volume Traded
(/ksweb/PutCall/activecontracts/2/OS)
• Top Value Traded
(/ksweb/PutCall/activecontracts/4/OS)
• Most Active Put
(/ksweb/PutCall/mostactiveput)
Investment Knowledge Bank
(/ksweb/Research/Kotak-Research- • BNST (/ksweb/Our-Offerings/Value-
• Share Market Basics
Center/Mutual-Fund-Research) Added-Features/Buy-Now-Sell-
(/ksweb/Research/Investment-
Tommrow)
Knowledge-Bank/share-market-basics) • Fundamental Analysis Reports
(/ksweb/Research/Kotak-Research- • TradeSmart Store (/ksweb/Our-
• What is Demat Account
Reports/Fundamental-Reports) Offerings/Value-Added-Features/Trade-
(/ksweb/Research/Investment-
• Technical Analysis Reports Smart-Store-Intro)
Knowledge-Bank/what-is-demat-
(/ksweb/Research/Kotak-Research- • SMS Alerts (/ksweb/Our-
account)
Reports/Technical-Reports) Offerings/Value-Added-Features/Stock-
• What are Derivatives?
• Derivative Reports SMS-Alerts)
(/ksweb/Research/Investment-
Knowledge-Bank/what-is-derivative- (/ksweb/Research/Kotak-Research- • AMO (/ksweb/Our-Offerings/Value-
trading) Reports/Derivatives-Reports) Added-Features/After-Market-Orders)

• Most Active Call • What are Futures? • Currency Derivative Reports

(/ksweb/PutCall/mostactivecall) (/ksweb/Research/Investment- (/ksweb/Research/Kotak-Research-

Knowledge-Bank/what-are-futures- Reports/Currency-Derivatives-Reports)
• Open Interest
(/ksweb/Historic/OpenInterest) contracts)

• What are Options?

• Highest in Premium
(/ksweb/Historic/HighPremium) (/ksweb/Research/Investment-
CUSTOMER CARE TOLL FREE

Knowledge-Bank/what-is-options-
• Put Call Ratio
trading)
1800 209 9191 / 1800 222 299 / 1800 209 9292
(/ksweb/PutCall/putcallratio)
• What are Mutual Funds? Alternate Number: 3030 5757
(/ksweb/Research/Investment-
(8.00 AM TO 6.00PM) To dial from Mobile phone add city STD code
knowledge-Bank/introduction-to-mutual-
Existing customers can send in their grievances to service.securities@kotak.com
funds)
(mailto:service.securities@kotak.com)
• Basics of Financial Planning
(/ksweb/Research/Investment-
Knowledge-Bank/financial-planning- CONNECT WITH US (https://www.facebook.com/kotaksecurities)
(https://twitter.com/kotaksecurities)
(https://www.youtube.com/user/KotakSe
(http://kotaksecurities.blogspot.in/)
(http://www.slideshare.net/Kota
overview)

• Calculators No need to issue cheques by investors while subscribing to IPO. Just write the bank account number and sign
(/ksweb/Research/Investment- in the application form to authorise your bank to make payment in case of allotment. No worries for refund as
Calculators) the money remains in investor's account.

• Videos (/ksweb/Research/Knowledge- KYC is one time exercise while dealing in securities markets - once KYC is done through a SEBI registered
Bank/Videos) intermediary (broker, DP, Mutual Fund etc.), you need not undergo the same process again when you
• Meaningful Minutes
approach another intermediary. Attention Investors Prevent Unauthorized Transactions in your demat / trading
(/ksweb/Research/Knowledge-
account --> Update your Mobile Number/ email Id with your stock broker / Depository Participant. Receive

Bank/Meaningful-Minutes)
information of your transactions directly from Exchanges on your mobile / email at the end of day and alerts on
your registered mobile for all debits and other important transactions in your demat account directly from
NSDL/ CDSL on the same day." - Issued in the interest of investors. Circular No.: NSDL/POLICY/2014/0094, NSE/INSP/27436, BSE - 20140901-21
Kotak Securities Ltd. bearing licence no. CA0268 is a Corporate Agent of Kotak Mahindra Old Mutual Life Insurance Ltd. We have taken reasonable measures to protect security and
confidentiality of the Customer Information.

Charges for Other Services (http://www.kotaksecurities.com/pdf/ChargesOtherServices.pdf) | Disclaimer (/ksweb/disclaimer) | Sitemap (/ksweb/Sitemap) | Privacy & Security (/ksweb/terms-
and-condition/privacy-security) | 256 Bit Encryption (/ksweb/256-bit-encryption) | BSE (http://www.bseindia.com/) | NSE (http://www.nseindia.com/) | MSE
(http://www.msei.in/index.aspx) | SEBI (http://www.sebi.gov.in/sebiweb/) | Anti Money Laundering Measures (/ksweb/Anti-Money-Laundering-Measures) | Important Policies
(/ksweb/Important-Policies) | Dos & Donts (/ksweb/Dos-and-donts) | National Pension System (http://www.kotak.com/nps/) | List of GST Registration Number
(http://www.kotaksecurities.com/pdf/GST.pdf)
(/ksweb) © 2005 Kotak Securities Limited.
Registered Office: 27 BKC, C 27, G Block, Bandra Kurla Complex, Bandra (E), Mumbai 400051. Telephone No.: +22 43360000, Fax No.: +22 67132430.
Correspondence Address: Infinity IT Park, Bldg. No 21, Opp. Film City Road, A K Vaidya Marg, Malad (East), Mumbai 400097. Telephone No: 42856825.
CIN: U99999MH1994PLC134051. SEBI Registration No: NSE INB/INF/INE 230808130, BSE INB 010808153/INF 011133230,
MSE INE 260808130/INB 260808135/INF 260808135, AMFI ARN 0164, PMS INP000000258 and Research Analyst INH000000586.
NSDL/CDSL: IN-DP-NSDL-23-97