ExpertGlossary

An uncovered option, also known as a naked option, is an option that is not backed by another position.

For example, if you sell a call option without owning the stock that you would have to deliver if the option holder exercised, the call is uncovered.

Similarly, if you sell an uncovered put, you don't have adequate cash in reserve to fulfill your obligation to purchase the underlying instrument at exercise.

Writing uncovered contracts can put you at significant risk despite the premium you collect when you open the position.

For example, if a naked call option were exercised and assigned to you, you would have to buy the underlying instrument at its market price to be able to meet the terms of the contract. Because of the potential risk, your brokerage firm may restrict your right to write uncovered positions or may require you to trade these options in a margin account.

An underlying instrument is a security, such as a stock, a commodity, or other type of financial product, such as a stock index, whose value determines the value of a derivative investment or product.

For example, if you own a stock option, the stock you have the right to buy or sell according to the terms of that option is the option's underlying instrument.

Underlying instruments may also be called underlying products, underlying interest, or sometimes the underlying investment.