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What is a naked writer

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Ken is considering to make an European call option on a non-dividend paying stock with strike price K = 60 which expires 6 months from now. The current price of the stock is 55.

(a) What is a naked writer? Explain why a naked writer of a call option could suffer from an infinite loss.

(b) What is a covered call? Explain how a covered call could provide insurance to writers of call options in terms of its payoff.

(c) Suppose the price of the call option is 6 and the continuously compounded risk-free rate is r = 3%. If the stock price 6 months from now is 90. Calculate the profit or loss (as at the expiration date) of Ken if he is a naked writer of one unit of the call option. Repeat your calculation if Ken has written one unit of covered call instead.

Reference no: EM132848759

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