Don't we all want to buy stocks at the beginning of a bullish trend? But we also worry that the stock price may not move and we waste a lot of time waiting.
We share what a naked Put contract is that can help you make consistent income even when the stock price doesn't move.
Contents
What Is a Naked Put Option?
Naked Put is a short Put strategy without having enough cash reserves to purchase 100 stocks. It is a bullish options strategy that becomes profitable if the stock price does not fall.
A short OTM Put option earns a premium upfront. The Put options value depreciates if the stock price stays above the strike price before the option expires. Then the strategy earns a profit.
Maximum profit = premium
If the option value expires worthless, the maximum profit of selling a naked Put is the premium.
If the AMD stock price falls below the strike price before expiration, we will be assigned 100 shares to purchase. But the naked Put strategy usually means there are not enough funds to buy the 100 stocks, so we would be forced to buy to close the Put option for a loss.
Loss = 100 x (strike price - stock price) - premium
Maximum loss = 100 x strike price - premium
The loss is calculated as 100 times the difference between the stock price and the strike price. If unfortunately, the company goes out of business, the maximum loss is 100 times the strike price.
Benefits of Selling Naked Puts
There are a few advantages of selling naked Puts:
- Naked Puts can generate steady income from the premium.
- It can be profitable even if the stock price stays neutral.
So we can continue to sell naked Puts if we feel the stock price is undervalued.
Risks of Naked Put Options
There are a few risks in trading naked Put options:
- If the account does not have enough cash to buy 100 stocks upon assignment, then we usually need to close the trade for a loss.
- The strategy doesn't put a limit on the maximum loss. If the company goes bankrupt, the trade loses 100 times the value of the strike price.
Strategies for Selling Naked Puts
The naked Put strategy is suitable for bullish stocks. So we prefer to use the Bullish Value Stocks screener to find undervalued stocks with more than 10% Upside. This way we have enough margin of safety to feel comfortable that the stock price will not fall shortly.
Best Stocks for Selling Naked Put Options
Once we filter the US stocks to find undervalued opportunities, we can choose our favourite stocks to sell naked Puts.
The most undervalued bullish stock right now is KSS. So we can sell a Put contract at around 20 delta that expires next month. Then we can make a profit if the stock price stays up.
But if the stock price falls sharply before expiration, our loss would be 100 times the difference between the market price and the strike price.
Better Alternatives to Naked Puts
Even though the naked Put is a simple bullish options strategy to use, we still worry about the potential risk of maximum losses. So we recommend a few alternative strategies in a bullish market:
- Selling Cash-Secured Puts lets us earn a premium while waiting for the right price to buy stocks.
- The Bull Put Credit Spread uses the least amount of buying power for a bullish trade, while also limiting the maximum losses.
Now you know how to earn a premium from naked Puts in a bullish market, you can start trading options for income.
