Selling naked puts is a strategy used by many investors in order to earn income. Other investors sell naked puts to get into a stock at a discount. Still other investor sell naked puts to be paid a premium and earn capital which they will eventually use to buy the underlying stock. Recently a forum member sold naked puts on McDonalds Stock. McDonalds Stock Symbol is MCD.
Presently he is hold the MCD stock put option May $95 strike which he sold for $2.07. I am not sure when the put options were sold but suffice to say with the stock now down to $91.90, the investor no longer wants to own McDonalds Stock at $95.00. To buy to close the MCD Stock May $95 naked puts would cost $3.20 for an overall loss of $1.13 or a loss of 54.58%. This investor has just 3 naked puts contracts so his loss if basically $339.00. But still it represents a loss of 54.58%.
I have often written about the importance of having a plan. I believe an investor needs to know in advance what his plan is before engaging in put selling. I believe put selling needs to be part of an overall strategy to be consistently successful. While this loss is on just 3 naked puts and it doesn’t seem that great, a loss of 54.58% if large and if an investor has enough of them he can easily damage his put selling portfolio.
Strategies To Save This Naked Puts Trade
What is needed is a couple of strategies that could be applied to this naked puts trade with MCD Stock tu turn it around into a profit position either now or down the road.
Learning From Past Naked Puts Mistakes
To do this it is important to look at McDonalds Stock Price Chart for the past 1 year to see what we can learn from the action in the stock, to see where mistakes have been made so they can be corrected, and to determine what price points should be considered for turning this trade back into a profit and eliminate the loss taken.All these steps are necessary to make sure this type of error is not repeated in the future.
By learning from past mistakes an investor becomes better at investing and more consistent in their returns. It is consistency of return that compounds capital.
MCD Stock Price 1 Year History Chart
Below is the period from May of last year to May of this year. The most important aspect of this chart is that McDonalds Stock has been above the 200 day moving average for the entire year until just recently.This is a bearish sign. This could signal that the long-term uptrend in MCD Stock is at an end. Looking long-term on McDonalds stock I can see there is some support in the $91.50 level but that support is weak. Instead stronger support lies at $90.00. Should that support break the stock could fall back to the mid to low $80.00.
The dividend at $2.80 annually will offer some support and this is a non-cyclical business with strong earnings. Economically if the recession in Europe is not as bad as expected, McDonalds stock could turn right around and move back higher should there be stronger earnings in the future.
McDonalds Stock Showing Weakness
i included the MCD Stock chart below to show investors who are selling naked puts with no desire to own the underlying shares, why consulting a stock’s chart is so important. On Jan 20 2012 McDonalds Stock set an intraday high of $102.02. Since then the stock has made a continual series of lower highs. Just glancing at this chart tells naked put sellers to consider a different stock for put selling as the series of lower highs is a clear warning that the stock is in trouble. If you look at the period before Jan 20 2012 you can see that the stock was making a series of higher highs as it continued to climb. That trend has now changed.
When selling naked puts, an investor should take time to review the stock’s history chart for clues about the underlying trend of the stock. In McDonalds Stock case the stock has declined consistently since it made a high on Jan 20 2012.
One other thing from the chart worth mentioning is the over-value territory I have marked. Based on the Price To Earnings ratio MCD Stock at $100 was trading at over 18.5 times price to earnings. This ratio for McDonalds stock is beyond its norm of 16.5 times. At 16.5 times McDonalds Stock would be trading around $88.27. Therefore once the stock reaches $88.00 it will be interesting to see if the downward trend breaks to a sideways trend. iof it does, then the stock will once again become a good contender for naked puts selling.
MCD Stock and The Early Warning Tools
Using the early warning tools to spot a collapsing stock, an investor who did not spot the series of lower highs in the chart above, could still have realized that the stock was in a downtrend and not sold naked puts. MCD Stock that has been in an uptrend continually fell back to the lower Bollinger and kept breaking the lower Bollinger band, a clear signal the stock is going to move lower as it is under selling pressure.
MACD Histogram And MCD Stock
The MACD histogram below went decidedly negative on Feb 8 2012. From that that day MACD has refused to turn decidedly positive but showed negative to flat readings throughout the downturn despite investors’ attempts to push MCD Stock back up. This again is a clear indication to not sell naked puts if the plan is to not be assigned shares. Why sell naked puts on a stock in a decline if the goal is to never own shares. There are so many stocks to choose from, when a stock begins to show the patterns we can see in MCD Stock, that is a signal to stop put selling and move to a different stock for naked put selling until this stock recovers. This is why having a list of stocks you follow is of significance. There is always something worthy of selling puts against. You can see from what I have indicated here the importance of strategy.
Naked Puts And What Has Been Learned
From the above charts an investor learns that selling puts against a declining stock is a poor idea if the goal is to never own shares. As well we have learned that a stock in over-valued territory is a stock to avoid. We have learned that stocks setting lower highs is a stock to avoid. We also know that MACD should remain positive throughout the naked put trade. if it doesn’t then it is time to consider closing the naked put trade. We also have learned that below $90.00 there is probably decent support and around $88.00 MCD Stock is fairly valued and could become a contender for put selling once again.
With the above information we can now decide what strategies to use to rescue these underwater naked puts and turn this losing trade into a profitable one.
In the second part we will look at strategies to consider for this losing naked puts trade.
Investor Relations For McDonalds Stock
Naked Puts Option Chain On MCD Stock