Beware the Naked Calls

Q What are "naked calls"? — F.J., Keene, N.H.

A They represent an investing strategy using options. Remember that there are two main kinds of options: "calls" and "puts." Owning a call gives you the right to buy a set number of shares, at a set price, within a certain period of time (often just a few months). For this right, you pay a price premium. Puts give you the right to sell shares.

You sell (or "write") naked calls when you don't own the underlying stock. It's risky because if the stock soars, you may have to buy it at the new high price in order to deliver it to whomever bought the call you sold. You can potentially lose a lot. Of course, if the stock doesn't pass the "strike price" before the option expires, you simply pocket the price of the option. That's why people write naked calls.

With the much more conservative covered-calls strategy, you sell a call only when you own the underlying stock and are willing to part with it, if need be. You can't lose money on the arrangement.

If the stock soars and someone exercises the option you sold them, you don't have to buy the shares at the new high price — you already own them and can hand them over, still having pocketed the price of the option. Of course, you may end up wishing you still owned the stock, if it keeps soaring.

Q What are "basis points"? — T.R., Morganton, N.C.

A Basis points are 1/100ths of a percentage point. So if you hear, say, that some interest rate is down 50 basis points, that means it's down half a percentage point.

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