Naked Put

Lets look at naked puts, when a put option is assigned the seller (i.e. option writer) is obliged to buy shares at a fixed price, regardless of what the current market price is. For example the stock may be trading at $19, but if the strike price of the option is $28 the option seller must buy the stock for $28.

It can now be seen why individual investors view this strategy as having limited reward and substantial risk. With the maximum profit limited to the premium received from selling the option. A Fund manager may view the strategy in a different way however.

By selling slightly out of the money puts, the stock will be able to be bought at a discount relative to the current market price if the stock moves down.  While at the same time earning additional income from the premium associated with the options. If the stock rises the investor hasn’t missed out entirely, they will keep the premium whilst the option will expire worthless.

Example: Say you were interested in buying International Business Machines (IBM), but think it is due for a correction from its current market price of $82.83. By selling the $80 puts for $5.10 you will receive $510 for each contract. If the stock drops to $75and the options are assigned to you, you will have to buy the stock for $80. Your net cost though is only $74.90 ($80-$5.10 premium) a bargain compared to buying the stock at $82.83!

Using ShareCharts Option Strategies for Naked Puts the entire transaction can be seen clearly. Go to Derivatives < Option Strategies and select Naked Put from the ‘Strategy’ Drop Down Box. Enter in all relevant parameters and click ‘Update’ to view the chart.