Risks of writing options
Writing options can be very risky, because once your buyer decides to exercise the option, you must follow through. So your potential losses could be substantial, even unlimited.
Uncovered options
The riskiest options are uncovered ("naked") calls. That's when you don't already own the security (or enough of the security) to sell the buyer if he or she chooses to exercise the call.
Because there's no limit to how high a stock price can rise, there's no limit to the amount of money you could lose writing uncovered calls. For this reason, many brokerages, like Vanguard, don't allow you to write uncovered calls.
Puts can also be uncovered, if you don't have enough cash in your brokerage account to buy the security at the option's strike price, should the option buyer choose to exercise it.
In that case, the additional risk is that you'll have to sell something else—or borrow from your broker—in order to raise cash to buy the security and close out the option.
Covered options
Even puts that are covered can have a high level of risk, because the security's price could drop all the way to zero, leaving you stuck buying worthless investments.
For covered calls, you won't lose cash—but you could be forced to sell the buyer a very valuable security for much less than its current worth. So there's no limit to your opportunity loss.
Let's look at some more examples.
