Selling Naked Puts

Selling Naked Puts

The naked put is a low-risk strategy, despite commonly held beliefs to the contrary 

The market risk of the naked (uncovered) put is identical to the market risk of a covered call. However, the two strategies also have important differences:

 

Uncovered put

Covered call

Dividends are not earned.

Dividends are earned as long as shares are held.

The uncovered put can be exercised, but this can be avoided easily, by closing the position, rolling it forward, or waiting for worthless expiration.

Covered calls can be exercised, and 100 shares of stock must be delivered at the strike. Exercise can be avoided by closing or rolling the in-the-money covered call.

Time is an advantage. The closer to expiration, the more rapidly time value declines. The uncovered put can be closed at a profit or allowed to expire worthless.

Time is an advantage. The closer to expiration, the more rapidly time value declines. The covered call can be closed at a profit or allowed to expire worthless.

Moneyness determines whether to close or roll the uncovered put. An out-of-the-money put will expire worthless; an in-the-money put is at risk of exercise.

Moneyness determines whether to close or roll the covered call. An out-of-the-money call will expire worthless and can be replaced; an in-the-money call is at risk of exercise, in which case shares will be given up at the strike.

Collateral is required equal to 20 percent of the strike value, minus premium received for selling the put. This is advantageous leverage when compared to the covered call.

No collateral is required for a covered call. However, to buy 100 shares of the underlying, 50 percent must be paid, and the remaining 50 percent is bought on margin.

 

The timing for opening a naked put is essential to reduce exposure to unwanted exercise. The best position for a naked put is when the underlying price moves through support and you expect price to retrace back into range. 

 

If you are selling naked puts to potentially create a new position in stocks it is a great way to reduce your cost basis and then be able to roll into covered calls to continue to collect premium.  There is a general perception that naked options are risky in general. But the problem is not the strategy. The problem is how you use it. Sure, if you sell naked options to get income and sell more than you can swallow, it can be a problem. But selling number of contracts only equal to number of shares you are willing to own is an excellent way to buy stocks at discount.