Selling naked put options

The options, by themselves, are not dangerous tools.

I mention that because one of the long-lasting misconceptions about options is that they are dangerous to use. It is possible to use options to speculate (gamble), but options were created as hedging, or risk-reducing, investment tools.

An alarming number of financial professionals, including stockbrokers, financial planners and journalists are in position to educate the public about the many advantages to be gained from adopting naked put writing (and other option strategies), but fail to do so. Many public investors never bother to make the effort to learn about options once they hear negative statements from professional advisors.

Except for extremely bearish prognosticators, no one ever suggests that owning stock is anything but the most prudent of investment strategies. Yet, writing naked puts is a significantly more conservative strategy and definitely less risky than simply buying and owning stocks. As such it deserves to be considered as an attractive investment alternative by millions of investors.

Who should consider writing naked (uncovered) puts?

1. Investors

• Who are bullish on the market
• Who are bullish on specific stocks
• Who want to buy a specific stock at a lower price
• Who adopt a buy and hold strategy
• Who want additional income from their holdings

2. Traders

• Who want a higher percentage of winning trades
• Willing to consider holding a position for a month or two
• Who want to begin a spread position with a bullish leg

Strategy Objective

Why would you want to write naked puts? What is there to be gained?

Writing naked puts is a bullish strategy. When selling naked put options, you are attempting to achieve one of two investment goals

• Profit. You are bullish on the stock and expect the put option to lose value, and perhaps expire worthless as time passes. If the latter happens, the option premium (cash from selling the put option) becomes the profit.
• Buy stock at a discount. If the put option is in the money when expiration arrives, you will be assigned an exercise notice and be obligated to buy the stock you want to own at a discount to today’s price. This is an intelligent method for an investor to gradually add positions to a long-term portfolio. NOTE: When you are eventually assigned that exercise notice, the stock may be below your target purchase price. However, if you had entered an order to buy stock at that target price, you would be in worse shape than the put seller (who cushioned any loss by the amount of the premium).

Another alternative is combining put selling with call selling, a strategy known as the Wheel strategy

This post was presented by Mark Wolfinger and is an extract from his latest book Writing Naked Puts (The Best Option Strategies). You can buy the book at Amazon or sign up for our free trial and get it for free.

Mark Wolfinger has been in the options business since 1977, when he began his career as a floor trader at the Chicago Board Options Exchange (CBOE). Mark has published four books about options. His Options For Rookies book is a classic primer and a must read for every options trader. Mark holds a BS from Brooklyn College and a PhD in chemistry from Northwestern University.