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Originally Posted by smyles
First, I believe "naked calls", "naked shorts", etc. is not a thing, at least in the SEC regulated space, so not sure why you even mention it. Second, again, the question is re mechanics of options contract underwriting. Simple reliance on "contract" is naïve, to say the least - just ask Madoffs clients.
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https://www.investopedia.com/terms/n/nakedcall.asp
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What Is a Naked Call?
A naked call is an options strategy in which an investor writes (sells) call options on the open market without owning the underlying security. This strategy is sometimes referred to as an uncovered call or an unhedged short call.
This stands in contrast to a covered call strategy, where the investor owns the underlying security on which the call options are written. A naked call can be compared with a naked put.
Understanding Naked Calls
A naked call gives an investor the ability to generate premium income without directly selling the underlying security. Essentially, the premium received is the sole motive for writing an uncovered call option. It is inherently risky as there is limited upside profit potential and, in theory, unlimited downside loss potential. In fact, the maximum gain is the premium that the option writer receives upfront, which is usually credited to their account. So, the goal for the writer is to have the option expire worthless.
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https://www.investopedia.com/terms/c/coveredcall.asp
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What Is a Covered Call?
A covered call refers to a financial transaction in which the investor selling call options owns an equivalent amount of the underlying security. To execute this an investor holding a long position in an asset then writes (sells) call options on that same asset to generate an income stream. The investor's long position in the asset is the "cover" because it means the seller can deliver the shares if the buyer of the call option chooses to exercise. If the investor simultaneously buys stock and writes call options against that stock position, it is known as a "buy-write" transaction.
Understanding Covered Calls
Covered calls are a neutral strategy, meaning the investor only expects a minor increase or decrease in the underlying stock price for the life of the written call option. This strategy is often employed when an investor has a short-term neutral view on the asset and for this reason holds the asset long and simultaneously has a short position via the option to generate income from the option premium.
Simply put, if an investor intends to hold the underlying stock for a long time but does not expect an appreciable price increase in the near term then they can generate income (premiums) for their account while they wait out the lull.
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But yes, my jab at "it's called contract for a reason" was a bit more tongue in cheek.