The Naked Put option strategy is used by beginners as well as seasoned options traders. It is a simple way to learn options and one that can add some extra income to your investment portfolio.
In this article we are going to cover :
What is a Naked Put?
Buying versus selling a Naked Put
Benefits of Selling a Naked Put?
When do we use a Naked Put?
How do we manage a Naked Put?
How do we put on a Naked Put?
And we will show you using a real example on the TastyWorks Option Trading Platform.
Let’s jump right into it.
What is a Naked Put Option?
A Naked Put is an option strategy where you sell a Put Option without owning the underlying stock.
It is considered a Naked Put because you are “naked” or exposed to the risk of having to buy shares of the underlying stock at the strike price if the option is exercised by the buyer.
Selling a Naked Put is a bullish strategy because you are expecting the stock price to go up. When it goes up you profit!
Buying Versus Selling A Naked Put
You can either buy or sell a Naked Put. The picture above shows shorting or selling a naked put.
If you sell a Naked Put, you are obligated to buy shares of the underlying stock at the strike price if the option is exercised.
However, if you buy a Naked Put, you have the right to purchase shares of the underlying stock at the strike price but are not obligated to do so.
The picture below shows the opposite which is buying a naked put.
What are the benefits of selling a Naked Put?
There are several advantages to selling a Naked Put.
The first advantage is that it can be used as a way to get into a stock at a lower price than the current market price. This is because you sell the put below the current price of the stock and hope the stock price will rise so you can buy it back at a lower price. However, if it doesn’t rise and the price moves below your strike price then you are assigned the stock. The price will be a lower price than the price when you placed the trade.
The second advantage is that it can be used as a way to generate income from your investment portfolio. This is because when you sell a put you collect the premium which is like getting paid for taking on the risk of having to buy shares of the underlying stock.
Lastly, selling a Naked Put utilizes less buying power than owning the stock outright. This allows the opportunity to make a higher ROI Return On Investment.
What are the downsides to selling a Naked Put?
You need to be comfortable with the risks involved in selling a Naked Put. The biggest risk is that the stock price can go down and you may be assigned the stock. If the stock continues down you lose money.
If the stock price goes up too much you will miss out on additional profits that you would have had if you owned the stock outright. However, we shouldn’t allow ourselves to think this way since we keep the premium collected upfront.
Now let’s talk about when to sell a Naked Put.
When should you Sell a Naked Put?
A Naked Put can be sold in several different situations.
It is a good strategy to use when you are bullish on a stock and think the price will go up.
It can also be used as a way to get into a stock at a lower price. So if you are bullish on the stock and want to own it, why not sell a Put and try to get it at a lower price? You can collect premium in the meantime.
Lastly, it is a good strategy to use to generate income from your investment portfolio. When you sell the naked put you collect a premium. If you are not assigned, you can roll the put to the following month and collect additional premium. You can continue doing this every month until you are assigned.
How do we sell a Naked Put?
Selling a Naked Put is relatively simple.
First, you need to choose the stock or ETF that you want to sell a Put on. You want to make sure that you are bullish and believe the stock price will increase in value.
Next, you need to choose the expiration date of the option contract. I suggest selecting the date that is closest to around 45 days to expiration. We pick this expiration date to maximize profit and minimize risk.
Lastly, you need to choose the strike price. This is the price that you are willing to buy shares of the underlying stock at.
That’s it! You have now sold a Naked Put.
Now let’s look at how to manage a Nake Put position.
How Do We Manage A Naked Put?
When trading short naked options, selling an option of the opposing type (i.e. selling a call against a short put that is being “tested”) can be one defense mechanism. This reduces the directional risk of the position and collects more premium, which extends the break-even point.
If the trader’s assumption on the underlying has not changed as expiration approaches, the position can be rolled to the next expiration cycle to extend the time in the trade and collect more premium.
When do we close a Naked Put?
Profitable Short Naked Puts will be closed at a more favorable price than the entry price (first goal: 50% of maximum profit)
How Do We Lose With A Short Naked Put?
It is very possible to lose when selling a Naked Put. The underlying stock price could drop, in which case you would be assigned the shares of the stock at the strike price and your loss would be equal to the difference between the strike price and the entry price, minus the premium collected.
The maximum loss for a naked put is unlimited as there is no limit to how low the underlying stock price can drop.
Selling A Naked Put Example
To better understand how selling a Naked Put works, let’s look at an example.
We are going to sell a naked put in SNAP. We will use the TastyWorks Trade platform. By the way I’ll put the link in the notes below if you want to open an account and get the free stock promotion. It is the option trade platform that I use most of the time and I think it’s the best for trading options.
So we are going to go to the trade tab and punch in the ticker SNAP up above. I like to use the curve mode so that I can visually see the profit zone in green.
We go to the strategy tab and hit short put option. The TastyWorks platform will automatically set you up to sell a short put.
In this case we are selling the 32 strike put for 3.05 with 36 days to expiration. So we are collecting $305 immediately upon placing this trade.
The BP effect which is buying power we are using is $549. So it is a cost-efficient way of investing. We are using $549 and collecting $305.
Now if you look at the green area which is the P&L at expiration, we see the max profit is $305 which is the amount we collected upfront. As long as the stock stays above the 32 strike price we keep the max profit.
We don’t start losing money until the stock moves down to just below 29. So if it stays where it is at or even moves down a little we still profit.
If the stock moves down below the 32 strike price we can be assigned at or before expiration. In that case we will own 100 shares (equal to 1 option contract) at $32. This price is still better to buy in at than the current $33.19.
So from here we hit review and send and then send order to place the trade.
We now have a 32 short naked put in SNAP!
Conclusion
The short naked put is strategy is a great strategy for generating income and buying a stock that you are bullish in at a better price than the current price.
Always do your research and consider your investment goals before you begin trading stock options. For more stock and financial information, please check out our other resources at OptionsFinanceProfits.com.
