Selling Naked Puts
For bullish investors who are interested in buying a stock at a price below the current market.
| Example | Increase in Volatility | Time Erosion |
| sell put | hurts position | helps position |
Buying stocks at a discount
Let's take the case of selling naked puts. When a put option is "put' (assigned), the seller (writer) is obligated to buy stock at a fixed price, regardless of the current market of the stock. For example, the stock might be trading at $20, but if the seller sold the 45 put (strike price of the option is $45), the option seller must buy the stock for $45 per share.
Given this scenario, it's easy to see why an individual investor would probably view selling naked puts as having limited reward and unlimited risk. The reality however is that the risk is limited, yes that's correct the stock can only fall to zero so in this case the risk would be limited to 45 (minus the premium received). This is a great way to buy stock wholesale.
By selling slightly out of the money puts, one is able to buy the stock at a discount (if the stock is put to them) relative to where it currently trades if the stock moves down in price. At the same time, the position would have earned additional income from the premium associated with the options. If the stock advances, naked put writers keep the premium collected from the options that expire worthless. Selling Naked puts as use in the latter way is often used to create monthly cash flow.
To truly appreciate this strategy, let's look at the following hypothetical example. Imagine that you want to buy Bubba Gump's stock (XYZ) but think it is due for a slight correction from its current price, $87. By selling the $85 puts at $5, you collect $500 ($5 x 100 shares) per contract. If the stock drops to $81 and the stock is "put" to you "assigned to you", you will pay $85 for the stock. However, your net cost is really $80 per share ($85 strike - $5 premium)-a relative bargain compared to buying the stock outright at $87!