Canadian Securities Course (CSC) Level 1 Practice Exam

What is the maximum risk of writing naked calls vs puts?

1. Naked call writers risk is limited

2. Put writers have theoretically unlimited risk

3. Naked call writers risk is theoretically unlimited

4. Put writers have limited risk

The correct answer is: Naked call writers risk is theoretically unlimited

The maximum risk associated with writing naked calls is theoretically unlimited. When a trader writes a naked call option, they are agreeing to sell the underlying asset at a specified price (the strike price) if the buyer of the call chooses to exercise the option. If the price of the underlying asset rises significantly above the strike price, the writer must still provide shares at that price, regardless of how high the market price is. Since there's no ceiling on how high the market price can go, the potential losses for a naked call writer can be infinite. In contrast, put writers do face a significant risk, but it is limited in that the maximum loss occurs if the underlying asset falls to $0, which means the loss would be capped at the strike price of the put option. This distinction highlights the extreme nature of naked call writing compared to writing puts.