Chris Rowe

Success With Naked Puts

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EXAMPLE NO. 2: SELLING A LOWER-STRIKE SPREAD

If you want a little more downside leeway (say, you think OIH may fluctuate to as low as $163.50), you might sell the March 165-160 put spread (instead of the March 170-165 spread).

In this case, you're giving up some upside in order to decrease the downside risk of OIH because you have a lower breakeven point.

If you sell the March 165-160 put spread, you could receive $1.50. Again, the risk is the difference between the strike prices minus the premiums received (which is $5 - $1.50 = $3.50).

At first glance, this may not seem smart when you consider the risk is $3.50 to make $1.50. However, let's say the odds of success have increased, and that OIH is trading at $170 and your breakeven point is now $163.50 (instead of $168 in the previous example).

Also, if you think about the risk of owning OIH, you'll recall that if the stock moved down to $163.50, you would already be down $6.50 a share. However, with a vertical spread, you're profitable if OIH is trading anywhere above $163.50.

EXAMPLE NO. 3: EXPANDING THE SPREAD

If you want to receive a larger premium, then you can sell the March 160-150 vertical put spread for $2. Notice that the difference in strike prices is now 10 points instead of five. This increases the dollar amount that you would risk, but it also increases the odds of success. The risk-versus-reward scenario is now 8-to-2.

If you sell just one March 160 Put and buy one March 150 Put against it, your maximum risk is $800 for each contract. This is because your risk is a 10-point strike price difference, minus the $2 received for selling the spread.

Your breakeven point is $158.

Your margin requirement is $800 per.

Read on for some tips to keep in mind before you start trading vertical put spreads. ...