An option is said to be naked if the person who writes the option (the option writer) does not own any of the underlying asset(s).
For example, someone might write a stock option offering to sell 100 IBM shares at price of $80 per share in three month’s time. The option is said to be naked if the writer does not own the shares he or she is offering to sell.
The writer of the call option above enters a legally binding contract to supply the person who buys the option with the underlying shares. (The writer of a put option enters a legally binding contract to purchase the underlying asset from the option buyer.)
The writer of a naked call option therefore enters a legally binding contract to supply the buyer with an asset the writer (seller) does not actually own. If the price of the underlying asset rises strongly, this can prove very expensive – perhaps catastrophically so – for the option writer.
Naked options can be classed as Naked Calls (the riskiest naked option to write) and Naked Puts.