Understanding Option Strategies

Options trading offers various strategies, each with a unique risk-reward profile. This tool helps compare **Naked** (unhedged) strategies, which carry higher risk but potentially higher reward, with **Hedged** (protected) strategies, designed to limit risk.

Naked Option Strategies

When you engage in a **naked option strategy**, you sell an options contract without owning the underlying asset or holding another options contract to offset the risk. This means you have an unhedged position, exposing you to potentially unlimited or substantial losses if the market moves significantly against your position, in exchange for earning the premium from the option sale.

• Naked Call: Selling a call option without owning the underlying stock. Profit is limited to the premium received, but losses can be theoretically unlimited if the stock price rises sharply.
• Naked Put: Selling a put option without having sufficient cash or a short position in the underlying stock. Profit is limited to the premium received, but losses can be substantial if the stock price drops significantly.

Hedged Option Strategies

In contrast, a **hedged option strategy** involves combining options with other positions (like owning the underlying stock) or other options contracts to limit potential losses. While these strategies often cap potential profits, they significantly reduce the downside risk, acting as a form of insurance for your investments.

• Covered Call: Selling a call option while owning the underlying stock. This generates income from the premium and offers limited protection against a minor price drop, but caps upside profit.
• Protective Put: Buying a put option on a stock you already own. This acts as an insurance policy, limiting your downside risk if the stock price falls, while still allowing for unlimited upside potential (minus the cost of the put).