From Diablo Wiki
A naked character is not a character you can see the 'bits' of, but rather just a character without any protective gear on.
In some games, naked is actually naked, with bits and all, but for most online RPGs, it's merely the player description for taking off all the gear of the character. In many cases this excludes rings, amulets or other trinkets.
It's not uncommon for players to remove all their gear, and start jumping, convulsively, especially when the "nude" model has as little clothes as possible - male or female. This has no particular purpose other than showing that the player is bored.
Certain play styles include the character being naked. With rings and amulets or without, this varies. The reason why this is interesting is because it dramatically increases the difficulty of gameplay, since most stat gains and resistances are based in the equipment.