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I was reading about selling calls, where there is a distinction between selling a naked call versus a covered call. I fail to understand why owning the underlying matters in the case the call's buyer exercises the option. For example, if the call option is on stock XYZ with a strike price of \$100, and at expiry the market price of XYZ is \$200 here are the two cases as I see them:

  1. If I don't already own stock XYZ, I will have to buy 100 of them at \$200 each from the market, and sell them to the option's buyer for \$100 each, losing \$100 $\times$ 100= \$10,000.
  2. If I happen to own 100 shares I can sell them directly to the option's buyer. However I'm giving away \$20,000 worth of stock and only getting \$10,000. This is a $10,000 loss.

My point is, I believe the stock is worth whatever it is worth at expiry, regardless of me owning shares or not. Isn't the P&L the same in either case? Are there any material differences between naked and covered calls? My guess is that buying a large amount of shares might move the share price against me. Is there anything else?

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Another way to look at it is that with a covered call, the stock is already in the box and so if they are called away from you, you will not have to buy the stock in the open market and therefore have less risk in the overall position.

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  • $\begingroup$ @user1337 I earlier made a comment that there were limted losses on a covered call. That was wrong. I reacted to other answers that initially said long put without thinking. A covered is actually equivalent to a SHORT PUT so you still have unlimited losses on the downside of the stock. My other comment remains true. $\endgroup$
    – AlRacoon
    Feb 13 at 12:55
  • $\begingroup$ @ anyone that upvoted my response for my remarks about unlimited loss, please feel free to retract your vote. $\endgroup$
    – AlRacoon
    Feb 13 at 13:21
  • $\begingroup$ +1 for being a gentleman $\endgroup$
    – user35980
    Feb 13 at 14:51
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A (short) naked call is a bearish trade (seller makes money in the form of premium if asset price falls) while a covered call is bullish trade (seller makes money if asset price rises). In this sense, a covered call $\equiv$ a naked put.

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The fact that you own the shares provides a hedge against losses on the call if the stock rises. And hedging is important in options trading. This is a very popular strategy (covered calls) and therefore is worth analyzing separately (if only to understand the shortcomings, i.e. it is true that you won't have a cash loss but you have a loss of the profits from the stock, an opportunity loss if you were planning to hold the stock indefinitely. Brokers often recommend this strategy to people who have stock they plan to hold indefinitely, on the grounds it will give them "extra income" compared to their current situation. That is a dubious rationale).

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