Which of the following is true regarding short option positions?

Regarding short option positions, it is accurate to categorize them as either covered or uncovered. Covered short positions occur when the trader owns the underlying asset that corresponds to the short position in the option, which can help mitigate risk because the trader has the underlying asset to deliver if the option is exercised. Uncovered (or naked) short positions, on the other hand, do not have the underlying asset backing them. This distinction is critical for managing risk and understanding how obligations arise from these positions.

The distinction between covered and uncovered positions is essential for investors to know since uncovered positions carry significantly higher risks than covered positions. The potential for loss in an uncovered short position is theoretically unlimited since there is no cap on how high the underlying asset’s price can rise, which means the short position could be exercised at a significant loss to the trader.

This understanding of covered versus uncovered positions is crucial for success in options trading, reflecting the complexity and risk management strategies investors must consider when engaging in this kind of trading.