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I set up a Yahoo forum for those interested in discussing selling stock
options for income including covered
calls, selling naked puts, spreads and other option and stock strategies.
This is a brief introduction to understanding
what is meant by selling puts or a naked put or cash secured
put and how it is used in a trade. This
brief outline will assist in forming a basis by which an
investor can then expand their knowledge to determine the
suitability of selling puts for their investing objectives.
naked put in its most basic
form is selecting a strike price for the put option, selling
that put strike which then gives someone the right to sell
you (assign) the stock to you at the strike price you have
STOCK ABC is trading at $50.00 on April 12 2010
The May 2010 $46.00 put is $1.00 bid and $1.10 ask (1
put = 100 shares)
Investor sells quantity of 1 $46.00 put for $1.00 premium
Breakeven on the Stock is $46.00 less $1.00 = $45.00
Income Earned $1.00 X 100 (shares) = $100.00
Capital at risk - $4,500.00
Return on Risk - $100.00 / $4,500.00 = 2.22%
Cushion between breakeven and present trading price = $50.00
- $45.00 = $5.00 or 10% - Therefore the stock must fall 10%
before the breakeven is reached which will put the trade in
jeopardy of assignment.
Why Is It Called A Naked Put?
It is called a "naked put" when sold, because
the investor who has sold the put, is "naked" the shares -
or to be even more simple - the investor does not own the
shares against which the put has been sold. The investor
then is "short" the shares in their account.
What Is The Maximum Risk?
The maximum risk of a naked put is the strike
price the investor has sold, less the premium made by
selling the naked put, which in my example is $100.00.
Therefore as per the example of our fictitious stock ABC,
which was trading at $50.00, the investor sold the $46.00
put, so the risk is that should the stock fall to $0.00, the
investor is at risk of having to pay $46.00 minus any
premium earned for selling the naked put, for the stock.
This means the total capital at risk is $4500.00. While this
may seem shocking, it is easy to stop such an event simply
through buying back the naked put if the stock appears to be
falling and the investor becomes concerned that the stock
may be collapsing to a price level they are uncomfortable
Buy To Close A Naked Put
It is important when selling naked puts to
consider whether or not you would want to own the stock at
the strike level you are considering selling naked puts at.
A put that is sold for $1.00 can easily end up costing $3.00
to buy back should the stock fall below the strike price
sold. In other words if you sold a naked put on our
fictitious ABC stock for the $46.00 strike for $1.00 and the
stock falls to $42.00, you will be assigned unless you
either buy back the put you sold, which is called "buy to
close", or you roll further out in time at the same strike
price or you roll further out and down to a lower strike.
(rolling naked put strategies are covered in other articles)
If at $42.00 you decided to buy back the naked put, in my
example stock ABC, it would cost more than $4.00 to buy
Use Of A Stop Loss
By buying back the naked put, you have
eliminated your obligation to purchase the shares of the
stock and you will not be assigned shares. If you buy back
the naked put for more than you received in premium when you
sold the naked put, then you have though taken a loss on the
option trade. This is why many investors who routinely sell
naked puts, establish a stop loss on their trade. A stop
loss is the value of the put which they will re-purchase it
for in order to end any further losses in the position. Just
as investors use a stop loss on a stock, an option seller
will do the same. It is important to establish a trading
strategy before selling the naked put so the investor has
clear price points at which they will buy back the naked put
should the trade not work in their favor.
When Can A Sold Naked Put Be Assigned?
Theoretically, when an investor has sold a
naked put, they can be assigned at any time up until expiry.
In reality a sold naked put can be assigned at any time when
the stock falls to or below the naked put strike price that
has been sold. Therefore in my fictitious example of stock
ABC it falls to $46.00 or lower, the investor can be
assigned shares right up until the day of expiry.
Bullish Or Ranged Bound
When an investor sells a naked put, they are
normally bullish that the stock will not fall or at the very
least it will go sideways. Most investors sell naked put for
income and usually sell one month out in time. This is
because time decay is the most rapid in the shortest time
frame. Therefore the put seller hopes that within the one
month period the stock will stay above the strike price
sold, allowing the put seller to capture all of the premium
earned through selling the naked put.
Buy Stocks At A Discount
Another reason for selling a put is to pick
up the stock at a discount to its current price. For
example, if our fictitious stock ABC is trading at $50.00
and the investor would prefer to purchase the stock at
$46.00, then he would sell a put for $46.00 and he is paid
the premium from the option sold. Then should the stock fall
to $46.00 or lower, the investor would be assigned (often
referred to as exercised) shares at $46.00.
The advantage is that not only does the
investor end up owning the stock for $46.00 rather than
$50.00, but he also keeps the put premium he made when he
sold the put. If, for example the put was sold for $1.00,
then the investor's cost in the stock is actually $46.00
less $1.00 which equals $45.00.
On the other hand if the stock does not fall
to $46,00 then the investor keeps the premium and can
attempt to sell another naked put for the next month out.
Selling Puts Monthly For Income
By selling puts every month and never being
assigned, an investor is earning an income while waiting for
the stock to fall in value. The income that is being earned
is reducing his cost of the stock so that, when eventually
he is assigned shares, his cost basis in the stock is
reduced by whatever put premium he has earned through
selling naked puts.
Selling Puts Are Net Credit Trades
Selling a naked put is a net credit trade. In
other words an investor who sells a naked put receives a
premium for selling the put. The premium is the price the
put was sold for. That premium is paid to the investor
within 24 hours. Therefore the profit earned from the trade
is deposited to the naked put seller's account within one
day of the trade even though the trade may have a month or
longer before it expires.
The maximum amount an investor can make on
the single naked put trade is the option premium they have
received from the sale of the naked put. In my example of
ABC, the investor will earn $100.00.
1) Selling naked puts consistently and with
great care can result in a regular monthly income from
rising or range bound stocks.
2) Selling naked puts can often allow the
investor to pick up stock at a discount to its current price
should the stock fall and the investor be assigned shares.
The premium received also reduces the cost of the entry into
1) In theory, Naked Puts expose the seller to
almost uncapped risk, should a stock they have sold naked
puts against, fall to zero in value and the naked put seller
does not buy to close their sold naked put options.
2) Should a stock begin to fall and the
investor accept assignment, they may be accepting shares in
a stock that has fundamentally changed and is now
This is a simple definition of naked puts. There are
numerous trade strategies and details on how to learn
successful naked put selling.