Is Selling Naked Puts Risky?

Selling naked puts has really gotten a bad rap throughout the years.  It is said to come with huge loss potentials and for that reason is reserved for only the most experienced traders.

But does the naked put strategy really deserve the bad rap it has gotten?  Well, it depends on how you use it.  Selling puts can be a wonderful way to make money and get into stocks, but if you get carried away the strategy could hurt you.

Let’s look at 2 different examples of selling naked puts.  In example 1 Mike has $3,000 that he wants to invest in an ETF or a strong equity.  He finds a fundamentally strong stock that is trading at $33.  Now he could go buy 90 shares of this stock and hold onto it, or he could sell the $30 put.

Mike decides to go with the second option and sell the $30 put.  From this he makes $150 up front and has the obligation to buy the stock at $30, if the stock goes to $30 or lower.  From here 1 of 2 things can happen.

1.       The stock goes below $30.  He buys it at $30 which is less then what we were going to pay for it anyways.  Mike also keeps the $150 premium he made and can hold onto the stock for the long term or

2.       The stock stays above $30.  The put Mike sold expires worthless and he walks away with $150.  Mike can also decide to sell another put next month because he has free capital.

In this case selling the put is not a bad thing.  In fact selling the put may be even safer than buying the stock outright because we make money up front, which lowers our cost.

In the Second example however Fred also has $3,000 to invest.  He decides to start selling naked puts on strong up trending stocks. 

He sells 1 put on XYZ stock, 1 put on ZTF, and 1 put on ABC, from these he makes $400, but is obligated to buy $10,000 worth of stock if everything turns against him.

In the second example Fred is selling naked puts with huge risks.  Each stock you sell a naked put on you must want to hold onto it for the long term, and must be able to buy the stock if you need to.  

If all the stocks turned against Fred he would have to buy them for $10,000.  But because he doesn’t have $10,000 in his account he will have to buy the puts back, which could possible take his account down to $0. 

In short, selling naked puts should be looked at from more of an investment standpoint, and not a trading standpoint.  If you are not willing to buy and hold the security you should not be selling naked puts on it.

For more information about naked puts visit http://www.stocks-simplified.com/Selling_Naked_Puts.html