Uncovered Option

An uncovered option, more commonly called a "naked" option, is an option contract sold (written) by a trader who does not hold an offsetting position that would let them deliver or absorb the underlying stock if the option is exercised. "Written" means the trader is the one collecting the premium upfront and taking on the obligation, rather than the one buying the option and holding the right.

To understand why this matters, compare it to a covered position. If you sell a call option covered by owning 100 shares of the stock per contract, and the buyer exercises it, you simply hand over shares you already own. If instead you sell that same call "naked," with no shares in your account, you must go into the market and buy the shares at whatever price they are trading at, then sell them to the option buyer at the lower strike price. That gap can be small or it can be enormous, and it is the entire risk of writing uncovered options.

The nuance that trips people up is that uncovered calls and uncovered puts have very different risk shapes. An uncovered call has theoretically unlimited risk, because a stock price has no ceiling, so the cost of buying shares to deliver could keep climbing indefinitely. An uncovered put has risk that is large but capped, because a stock price cannot fall below zero, so the maximum loss is limited to the strike price (minus the premium collected) if the stock goes to zero.

Because of this asymmetric and potentially large risk, brokers restrict who can write uncovered options. This typically requires a higher options approval level, a margin account, and posting collateral that gets recalculated as the underlying price moves, and it is subject to exchange and regulatory margin rules that set minimum collateral requirements.