Uncovered Call Writing Risks
Don't forget the importance of risk assessment in determining what is an appropriate investment or strategy. Consider the risks involved with writing uncovered calls, especially in light of limitations that are placed on your activity by brokerage firms. These limitations are necessary due to the risk of potential losses. Restrictions that are placed on naked call writing limit your ability to participate in the high-risk end of this market.
The risks of uncovered call writing include the following:
- The stock might rise in value; you will be required to buy the call to close your position and avoid further loss.
- The stock might rise in value, leading to exercise, perhaps early exercise.
- Although the stock might remain at or below striking price for a period of time, it could rise unexpectedly and suddenly, leading to exercise; you are at risk from the moment you sell the call, all the way to expiration.
- You lose opportunities to move your capital around in the market because your brokerage firm wants to limit your risk of loss as well as theirs; so your equity is committed as collateral for your open uncovered call positions.
- If you do suffer unexpected large losses, your brokerage firm may sell other securities in your portfolio to pay for those losses.
- Although you set standards for yourself, you might fail to take action when you should, so that today's profit disappears and you end up losing money upon exercise or having to buy the call at a loss to avoid exercise.