Uncovered Option

What is an ‘Uncovered Option’

An uncovered option is a type of options contract that is not backed by an offsetting position that would help mitigate risk. “Trading naked”, as it is called, poses significant risks. However, an uncovered options contract can be profitable for the writer if the buyer cannot exercise the option because it is out of the money.

Explaining ‘Uncovered Option’

If a market participant sells a call option without owning the underlying instrument, the call is uncovered. If the buyer exercises his or her right to purchase to underlying instrument, the person who sold the call option (the writer) will need to buy the underlying instrument at its current market price in order to fulfill the contract.

Further Reading

  • Currency option pricing with mean reversion and uncovered interest parity: A revision of the Garman-Kohlhagen model – www.sciencedirect.com [PDF]
  • The arbitrage principle in financial economics – www.aeaweb.org [PDF]
  • Foreign-currency bonds: Currency choice and the role of uncovered and covered interest parity – www.tandfonline.com [PDF]
  • Monetary policy uncovered: theory and practice – www.tandfonline.com [PDF]
  • The economics of the uncovered interest parity condition for emerging markets – onlinelibrary.wiley.com [PDF]
  • Financial market complexity – ideas.repec.org [PDF]
  • Testing the uncovered interest parity using traded volatility, a time-varying risk premium and heterogeneous expectations – www.sciencedirect.com [PDF]
  • Some structural hypotheses in a multivariate cointegration analysis of the purchasing power parity and the uncovered interest parity for UK – ideas.repec.org [PDF]