Naked Put
Risk: high
Reward: limited
General Description
Entering a naked put position entails selling puts (most likely in-the-money).
The Thinking
This strategy is employed when you are very bullish. If the stock rallies above the strike price you keep the entire premium, but you have huge risk to the downside if the stock drops. You would then have to either buy the puts back at a much higher price or the stock would get “put” to you, and you would show an immediate loss.
Example
Let's say IBM is trading @ $82.83 and you think a big rally is coming soon. You sell the 80 put options for $5.10.
Your max profit is the premium collected from selling the puts. As long as the stock closes above 80, you keep the entire premium. Simple as that. Your breakeven point is 74.9 – at that price the 80 puts will be worth $5.10 (80.0 – 74.9). Below 74.9 you will lose money at the same rate as if you owned the stock. You will then have to buy the puts at a much higher price or let the stock be “put” to you at $80/share and show an immediate loss. Between 74.9 and 80 you will have a profit but less than the max.
The image below summarizes the trade with a P/L Diagram. |
