What defines a "naked" option?

A "naked" option is defined as an options position where the seller does not hold an offsetting position in the underlying asset. This means that the seller is exposed to significant risk, as they do not own the underlying asset that they have sold options against. For example, if a trader sells a naked call option, they are obligated to deliver the underlying asset at the option's strike price if it is exercised, but they do not own that asset. This lack of a corresponding position means that if the market moves against them, they could face substantial losses, as they would need to purchase the asset at potentially much higher market prices to fulfill the terms of the option contract.

The other choices reflect different concepts in options trading. The first describes a covered option, where the seller holds the corresponding asset, thus mitigating risk. The third option discusses the notion of premium, which relates to the cost of buying options but does not define the naked position. Lastly, the fourth option refers to an option's exercise status, which is unrelated to whether the position is considered naked or not.