Selling Naked Puts Can Provide Expensive Portfolio Clothing
Bryan Perry, Editor of Quick Income Trader
One of the most successful option strategies that gets little to no press is that of selling naked puts on common stocks. All the attention is given to the massive call purchases on short-term, out-of-the-money contracts that offer the most potential exponential returns. But they also make for the most risky of all options trading strategies, and that is why 90% of those types of trades expire worthless. That’s not a typo.
Like any trading strategy that employs the use of a time-wasting asset, like options, the element of time can either be your friend or your enemy. If one is long call or put options with relatively short-term expiration dates, the time value portion of that trade literally loses value every day, especially if the option has an out-of-the-money strike price. In fact, any out-of-the-money call or put option is made up entirely of time value. There is no intrinsic value, and thus the clock is ticking when that trade is executed.
Conversely, when one sells a naked put or call against the value of a common stock, the time value associated with that contract will also erode just the same. But the result is rising profits because that option has already been sold first and is expected to be bought back later at a lower price than the price point at which it was sold. Time is on your side. How cool is that?
Take, for instance, a stock like PayPal Holdings (PYPL), a rising leader in mobile digital payments. The stock broke out to the upside back in May 2017 and has been in a steady up-and-to-the-right trend since, fueled by an impressive streak of strong earnings reports and high-profile partnerships. It’s well positioned in a sector that has powerful secular tailwinds that should continue to catalyze growth.
The stock hit a recent high of $65.24 before taking a breather and pulling back to $62.50, where it found support at its 20-day moving average. My two-month price target for the stock is $67 on a purely technical basis and a belief in a market that will maintain its bullish bias.
By selling the PayPal November $62.50 puts for $2.00 per contract ($2.00 per contract = $200 in dollars), a trader who holds the same bullish view of the stock can sell five contracts at-the-money and have their account credited $1,000 immediately. And who doesn’t like getting paid immediately?
If shares of PayPal close a penny above $62.50 on Nov. 20, which is when November options expire, those five contracts will expire worthless and 100% of that same $1,000 will be banked. If the stock closes below $62.50 on Nov. 20, that same account will be “put” or “assigned” 500 shares of PayPal that will cost about $31,000 in cash or about $16,000 on margin. So it’s important to have enough cash or buying power at the ready if there is risk of being put the stock in one’s account.
Remember, one contract represents the right to buy or sell 100 shares of the correlating stock. If one is assigned the stock because of a closing price below $62.50, the $2.00 in option premium is still banked and the cost basis of the shares has now been reduced by $2.00 to $60.50 per share.
It’s at that time when one might seek to either keep the stock or elect to sell it at a higher price. What is important here is to only sell “naked puts” on a stock that you don’t mind having to own if the short-term price movement goes against you. In the case of PayPal, it’s one of the market darlings and makes for a fine hold if need be.
The reason selling naked puts isn’t as sexy as the straight-out buying of calls and puts is because your potential profit is defined right up front. The PayPal trade will produce a maximum profit of $2.00 per contract because you are selling first and buying back at a hopefully lower price or letting the option expire worthless. For those that want more profit potential, here’s how:
With that same $67 two-month price target in mind, one can sell an in-the-money PayPal November $67.50 put for $4.50 per contract, or $450 in real dollars. On the sale of 5 put contracts, one is collecting $2,250 right away and if PayPal stock closes above $67.50 on Nov. 20, 100% of that $2,250 is kept. Not bad for a two-month trade. This is clearly more appealing, but it involves PayPal shares having to rally by five points.
Clearly, this is not a widows-and-orphans income strategy. But with the right stocks and some consistently good technical timing, it can be a wonderfully exciting way for investors to win 80-90% of the time. And that’s exactly what’s happening in my Quick Income Trader advisory. Of all the naked put strategies I’ve recommended, we’re winning on 82% of all recommended trades with an average holding period of less than 30 days.
To find out more about how to profit from selling naked puts in a bull market, click here and get your trading capital working for you in a smart manner that puts time on your side and money in your pocket quickly. That’s why we call it Quick Income Trader. This is what many long-life options pros do every day in their own accounts.Back