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Selling Naked Puts
The Smart Profits Report: Issue #278
Thursday, January 26, 2006
Selling Naked Puts - Get Paid Now To Buy Your Favorite Stocks Later… At A Bargain
By Lee Lowell
Advisory Panelist, Mt. Vernon Research
How would you like to get paid today just for the opportunity to buy Intel when it bottoms out? Think it can’t be done? Brokering your own commission is easier than it sounds.
Intel (Nasdaq: INTC) recently plunged 11% in one day, after reporting disappointing earnings. The stock hasn’t fared much better since then. Sellers have shaved four points off its share price. But for anyone who has held off owning shares of INTC, now could be the time to get in.
There are multiple ways of taking advantage of a situation like this, but let’s look at a defensive strategy for getting in like selling naked puts…
Pocket Cash By Using a Naked Put
Time and time again, I’ve seen shares of good companies get hammered just like INTC, only to work their way higher over the course of the following few weeks or months. This is the perma-bullish attitude of the majority of the market. What’s more, Intel is not some fly-by-night operation. I’m not willing to bet against a company that controls about 95% of the computer chip market. Its microprocessors are being installed in just about every new PC that’s manufactured.
Having said that, I think Intel may well be heading lower over the next few weeks and months before its rebound. So, there’s the short-term and long-term equation.
Here’s a monthly chart of INTC going back to 1997:
Other than the dip to about $12.95/share in 2002, INTC has had pretty good support in the $15-$20 range. As of today, INTC is trading around $21.60/share.
Here’s the good news: If you’re looking to buy Intel at, say, $20/share (and please note, this an example, not a recommendation), selling naked puts is a great way to 1) own the shares if they do in fact reach $20, and 2) get compensated while you’re waiting. Here’s how selling naked puts works…
You pick a price level that you would like to pay for the stock - in this case, $20. Then you sell put option contracts that correspond as closely to that level as possible. When you sell naked put options, you have an obligation to buy 100 shares of stock for every option contract you sell.
Right now, INTC is at $21.60/share, but if it trades lower than $20, you’ll be forced to buy 100 shares at $20 no matter how much lower INTC may be. If INTC falls down to $18, you’re still obligated to buy the shares at $20. But that’s okay, as that is what you set out to do in the first place - own shares at a lower price.
One of the great benefits of selling naked put options is that you collect the premium from selling the options to the buyer. You get this money up front and it’s deposited into your trading account. Once the trade is executed, all you have to do is wait to see if INTC falls below the strike by option expiration. If it does, you will be assigned on your trade, meaning you will have to purchase 100 shares of stock at the stated strike price.
If the stock does not fall below your strike price by option expiration, the trade is dead, but you get to keep the premium you were paid up front. So, at least you’re compensated for your time to see if you ever get assigned the shares.
Be warned, this is not a strategy for everybody, and not everyone can be approved to sell naked options. The reason for the warning is because someone might get caught up in the frenzy of selling options just to take in the premium. Don’t do this!
Only sell naked puts on stocks that you definitely have a desire to keep in your portfolio. And don’t sell more put option contracts than you’re comfortable owning. If you normally trade in 500 share stock increments, don’t sell more than five put options.
Check with your brokerage firm to see if you can be approved for naked put selling in your trading account. (Brokerage houses consider selling naked options taboo and have strict guidelines for the type of account you must have in order to do this.) In my view, it’s not a risky strategy as long as you don’t abuse it. It’s no more risky than selling covered calls, and brokerage houses consider covered calls as safe as you can get.
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Today’s Smart Profits Cribsheet
- Today we’ve looked at how to get the desired price for a stock you’ve been waiting to own. To learn how to make money by taking advantage of options that expire worthless, check out Smart Profits #255, Out of the Money Options - Buyer Beware, Seller… Take The Money.
- Check out the Smart Profits Glossary, chock full of over 150 options terms, like “naked option” or “strike price” from the article above.
- While we’re on the subject of selling naked puts, I’d like to mention that I’ve put together a special electronic report on how you can profit from investors buying options out-of-the-money. The report, How to Receive Instant Cash Payments for “Locking In” Lower Prices on Your Favorite Stocks, is a handbook that can be e-mailed right to your inbox…
Good Trading,
Lee
Related Articles:
- Sell First, Buy Second for 50% Better Odds
- Limit Orders vs. Naked Puts - Getting Paid to Place Them On Your Favorite Stock
- Short Selling - Beating the Government By Going Short
