Definition of Uncovered option
Uncovered option is the one that lacks balancing mechanisms to help moderate risk.”In other words, “trading naked” poses serious risks. In the case of insufficient cash, a revealed alternative contract might be lucrative for the author. For the most part, uncovered options are appropriate just for experienced, educated financial specialists who comprehend the risks and can manage the cost of considerable misfortunes. Hence, it is also called a “naked option.”
A market participant who offers a call option without owning the basic instrument exposes the call. For example, suppose the purchaser practices his or her entitlement to buy the fundamental instrument. In order to fulfill the contract, the seller (the author) must buy the hidden instrument at its current market price. Because of inherent risks in exchanging revealed alternatives, many agents confine account holders from composing revealed choice positions, in this manner restricting customers’ exposure to unlimited market risk.