Explain the Concept of “Collateralization” in the Context of Writing a Derivative Contract

Collateralization is the process of posting assets (collateral) to secure the potential obligations of a derivative contract, particularly when writing (selling) options or engaging in margin trading. For a covered call, the underlying asset itself acts as collateral.

For naked options or futures, cash or other assets are required as margin to cover potential losses, ensuring the counterparty is protected against default.