Options Risks Explained Honestly: Leverage, Total Loss, Naked Calls, Liquidity, and Assignment

Options are risky mainly because of leverage: a small amount of money controls exposure to 100 shares, so small moves in the stock become large percentage gains or losses in the option. Buyers can lose 100% of what they pay, often in weeks, and sellers of uncovered calls can lose far more than they ever received, with no theoretical limit.

In short: the main risks are (1) leverage, which magnifies both gains and losses; (2) total loss of premium, since most out-of-the-money options expire worthless if the stock doesn’t move enough, soon enough; (3) unlimited loss on naked calls and large losses on short puts; (4) costs and liquidity, because options spreads are much wider than stock spreads; (5) assignment, which can turn an options position into a stock position, or a margin call, without warning; and (6) volatility and time, which can make an option lose value even when you are right about the direction.

Why this article exists

Options are often marketed as a way to get more from a small account. The mechanics, explained in what is an option, are not inherently good or bad: insurers, pension funds, and market makers use them every day. But the risks are lopsided in ways that are easy to miss, and the academic evidence on retail options traders is not encouraging. That evidence is covered in why most options buyers lose. This article focuses on the mechanics of loss.

Every US options investor must receive the Options Disclosure Document, “Characteristics and Risks of Standardized Options,” published by the Options Clearing Corporation, before their account is approved for options. It is long, dry, and worth reading.

Risk 1: leverage cuts both ways

Hypothetical Maple Widgets Inc. trades at $50. Compare two positions held for three months:

Stock: buy 100 shares for $5,000.
Option: buy one three-month $50 call. At 30% implied volatility and a 4% rate, the Black-Scholes price is about $3.23, so one contract costs $323.

At expiry:

Stock price at expiry	100 shares: P&L	Return	One call: P&L	Return
$45	minus $500	minus 10%	minus $323	minus 100%
$50	$0	0%	minus $323	minus 100%
$53.23	+$323	+6.5%	$0	0%
$55	+$500	+10%	+$177	+55%
$60	+$1,000	+20%	+$677	+210%

The call’s dollar loss is smaller (its maximum is $323), but its percentage loss is total in two of five scenarios, including the one where the stock simply doesn’t move. The stock needs to rise 6.5% in three months for the call buyer to break even. That is the cost of the call’s limited downside: the premium is spent whether or not the stock moves.

The real danger of leverage is position sizing. Someone who puts $5,000 into calls instead of $323 now controls about 15 contracts, or roughly 1,500 shares of exposure, and a flat stock wipes out the whole $5,000.

Risk 2: losing the whole premium

An option buyer’s maximum loss is the premium paid, plus commissions. That sounds like a safety feature, and it is a limit. But it is also the most common outcome for out-of-the-money options held to expiry: if the stock finishes on the wrong side of the strike, the option is worth zero.

Three forces work against buyers at once:

Direction: the stock has to move the right way.
Magnitude: it has to move far enough to cover the premium.
Timing: it has to do so before expiry, while time decay erodes the option every day.

Being right about one or two of these is not enough. Time decay does its damage quietly, a little every day, and fastest in the final weeks.

Risk 3: naked calls and short puts

Naked (uncovered) calls

Selling a call you don’t cover with shares creates an obligation to deliver stock at the strike price, whatever the stock costs to buy at the time. Suppose you sell one three-month Maple Widgets $55 call for $1.39, collecting $139. Your breakeven at expiry is $56.39.

Stock price at expiry	Your P&L
$50	+$139 (the maximum)
$56.39	$0
$60	minus $361
$70	minus $1,361
$100	minus $4,361
$150	minus $9,361

The gain is capped at $139. The loss is not capped, because there is no ceiling on a stock price. Takeover bids, short squeezes, and meme-driven rallies have all produced moves of this size. Brokers generally reserve naked call writing for the highest options approval level and require substantial margin, as explained in options approval levels.

Short puts

Selling a put obligates you to buy shares at the strike. If you sell a three-month $45 put for about $0.90 ($90) and the stock falls to $30, you are buying $3,000 worth of stock for $4,500: a loss of $1,410 after the premium. If the company fails and the stock goes to zero, the loss is $4,410. That is a limited loss, but it can be 49 times the premium collected.

Risk 4: spreads, costs, and liquidity

Options trade with much wider bid-ask spreads than stocks, measured as a percentage of price. In their study of US retail options trading from November 2019 to June 2021, Bryzgalova, Pavlova, and Sikorskaya (Journal of Finance, 2023) found that half of retail trades were in options with less than a week to expiry, and that those options had an average quoted bid-ask spread of 12.6%.

What that means in practice: on an option quoted $0.94 bid, $1.06 ask (a 12% spread on a $1.00 midpoint), buying at the ask and immediately selling at the bid loses $12 per contract, before the stock has moved at all. Commission-free trading does not remove this cost; it is built into the price you pay.

Liquidity also varies sharply by strike and expiry. Far-dated or far out-of-the-money contracts on smaller stocks can have very few trades and wide spreads, and the price you can actually exit at in a fast market may be far from the last quoted price.

Risk 5: assignment

If you sell an American-style option, the buyer can exercise it on any business day, and the Options Clearing Corporation assigns exercises randomly among clearing firms with short positions. Your broker then allocates them among its customers, by a random or first-in, first-out method. The mechanics are in how exercise and assignment work.

Assignment surprises include:

Early assignment on short calls before ex-dividend dates, which can leave you short stock and owing the dividend.
One leg of a spread assigned while the other remains open, temporarily turning a defined-risk spread into a stock position.
Expiration-day uncertainty when the stock closes near the strike, and after-hours moves that change whether options are exercised.

Each of these is covered in the dedicated article on assignment risk, linked below.

Risk 6: volatility and time, even when you’re right

An option’s price depends on implied volatility as well as the stock price. Before earnings, implied volatility rises; afterwards it typically collapses. A call bought before earnings can lose money even if the stock rises, if the rise is smaller than what was priced in. A worked example is in implied volatility explained.

How the risk profile differs by position

Position	Maximum gain	Maximum loss	Main risk
Long call	unlimited	premium paid	time decay, total loss
Long put	strike minus premium	premium paid	time decay, total loss
Short (naked) call	premium received	unlimited	large upside moves
Short put	premium received	strike minus premium	large downside moves, assignment
Covered call	strike minus stock cost plus premium	stock cost minus premium	stock falls; upside capped
Debit or credit spread	defined	defined, if both legs stay open	early assignment of the short leg, legs settling differently at expiry

“Defined risk” on a spread holds only while both legs exist. If the short leg is assigned early or the legs settle differently at expiration, the position becomes something else, as covered in what happens at expiration.

In Canada

The mechanics are the same for options listed on the Montreal Exchange. Canadian investment dealers are regulated by CIRO, and options trading also requires account approval and a risk disclosure statement from the dealer. Registered accounts such as TFSAs and RRSPs restrict which options strategies are allowed, generally excluding uncovered short options.

Other risks that catch people out

Gaps. Stop orders do not protect an options position from an overnight move; most equity options trade only during regular market hours, so a position can’t be adjusted while the stock moves in pre-market or after-hours trading.
Margin calls. Short options positions require margin that can rise quickly as prices move, and brokers can close positions without asking you first.
Complexity. Multi-leg strategies have more moving parts, more commissions, and more ways for one leg to behave unexpectedly.
Contract adjustments. Splits, mergers, and special dividends can change what an option delivers, which can make the contract trade differently from what you expected.
Behaviour. The speed and leverage of options make it easy to trade more often and in larger size than intended.

Takeaway

Options risk is not one thing. Buyers mostly face a high chance of losing the whole premium, through time decay, volatility, and wide spreads. Sellers mostly face rare but very large losses, unlimited in the case of naked calls. Everyone faces leverage, assignment surprises, and costs that are larger than they look. Understanding the arithmetic of each before taking a position is the minimum.