Chris Rowe

Success With Naked Puts

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Here's a quick review on selling naked puts. (Please note that the following example is used for illustrative purposes, using sample prices, and is not a recommendation.)

The Stock Trader's Profit/Loss Scenario

If a stock trader buys 100 shares of the Oil HOLDRs Trust (OIH), an oil-service Exchange-Traded Fund, at $170:

• Requirement: $17,000 cash or $8,500 on margin
• Maximum upside potential: Infinite
• Downside risk: $17,000
• Breakeven price: $170

The Put Seller's Profit/Loss Scenario

Consider the seller of one naked put option. (Note: If the seller is "assigned" by the option buyer, this means that the seller would be obligated to buy 100 shares of OIH at the strike price.)

Let's stay with our example of the OIH trading at $170.

In this example, we will use the OIH March 170 Put option, which is trading at $7. By selling one naked put option contract, we are saying we are willing to buy 100 shares of OIH at $170 upon request before March options expiration. In exchange for the put option contract that we are selling, we get $700.

• Requirement: Strike price x 100 shares - premium received ($17,000 - $700 = $16,300) in a non-margin account. However this is typically done in a margin account with a 20% requirement. ($16,300 x 0.20 = $3,260 cash outlay)



NOTE: Be sure to check with your options trading broker about their specific margin requirements before trying this or any strategy for the first time.

• Maximum Upside Potential: There are two possibilities.
  
  The upside if the person who purchased the March 170 Put does not exercise the put option (because OIH moved much higher, making it pointless to exercise) is the 7-point ($700) premium received for the put option that we sold.
  
  The upside if the person who purchased the March 170 Put does exercise the put option is infinite (because, then they'd actually own 100 shares of OIH).


• Downside risk: Strike Price x 100 shares - premium received ($17,000 - $700 = $16,300)


• Breakeven point: $163.