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The word 'naked' in relation to options is synonymous with unlimited risk. But 'naked' puts are limited risk, the risk is limited to the strike price. So , why is it classified in the same category by most brokers, particularly if it is an RRSP/TFSA type account

5

So, yes, you may be having the inevitable epiphany where you realize that options can synthetically replicate the same risk profile of owning stock outright. Allowing you to manipulate risk and circumvent margin requirement differences amongst asset classes.

Naked short puts are analogous to a covered call, but may have different (lesser) margin requirements. This allows you to increase your risk, and the broker has to account for that.

The broker's clientele might not understand all the risks associated with that much leverage and so may simply consider it risky "for your protection"

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  • Thanks. How does it help to 'circumvent margin requirements'. I am still under the naive impression that using margin is dangerous, so i am not sure how I can gain by circumventing margin requirements. is it just experience, or is there a book i can read on how to use margin?
    – Victor123
    Mar 3 '15 at 18:23
  • @Victor123 loaded question, I don't have a direct answer to these things, try asking a new question on this site.
    – CQM
    Mar 3 '15 at 22:49
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Naked does not mean unlimited risk. It refers to an option contract where one does not have a position in the underlying security.

In the US, Reg T margin on naked options is approximately 20% whereas for the synthetically equivalent covered call, it's closer to 50%.

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For instance the stock is trading at 55. A option-writer writes a put at a strike price of 50. The stock drops from 55 to 50 but the option-writer doesn't mind buying the stock at 50. However, the option's time is not yet up and the stock drops to 25 after a couple more weeks. Now the option-writer must pay 50 for a stock that is trading at 25.

The option-writer would have had to speculatively closed the option position, probably at an intermediate loss, to avoid further downside.

And suppose that the option-writer received a premium of 2 for writing the put. The downside, looking forward to option expiration, begins at 48.

If this were a situation of a cash-secured-put write, then the maximum possible loss is 4800 or actually 2300 as in the example.

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It also depends on the asset. For example, a commodity like natural gas, which is how Cordier lost his hedge fund creating a "catastrophic loss event". https://hedgetrade.com/hedge-fund-nightmare-poor-risk-management/

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