|Jul 7, 2010
Selling Naked Puts
naked options is considered to be a
risky proposition by most people who understand how options work.
However, there is one situation in which selling an uncovered option is
a play I can endorse.
When you sell a call option, you
may be obligated to sell 100 shares of stock. Because the price could
rise with no potential limit, the risk is unlimited. In the real world
we know that stocks cannot rise without limit, but the prudent investor
avoids selling naked calls. It's a strategy for experienced traders.
The situation is similar with
naked puts, but there is a significant difference. The put seller may
be forced to buy stock, and we know there is a limit on how much can be
lost. The price cannot go below zero.
When would you consider
selling naked puts?
This strategy can lose
substantial sums in a bear market. My recommendation is to sell naked
put options under only one condition:You want to own the shares and
can afford to pay for them.
Let's compare the alternatives:
Sell put instead of buying
- Buy 100 shares of XYZ @ $40 per share. Investment $4,000.
- Maximum loss $4000
- Maximum gain, unlimited
When selling puts instead of
buying stock, the maximum loss is reduced by the option premium
collected. The bad news is that the maximum gain is limited to that
- Sell 1 XYZ Apr 40 put @ $3 and collect $300
- Maximum gain is $300. (option expires worthless)
- Earn interest on the cash not used to pay for stock
- Maximum loss $3,700. (If you are forced to buy the stock
@ $40 and it becomes worthless)
Selling puts reduces the risk of stock ownership and is therefore a
reasonable alternative to buying stock. If buying stock is the
investment you want to make.
Mark D Wolfinger
Expiring Monthly: The Option Traders Journal