Naked Put
Description
A naked put (also called an uncovered put) is a put option where the option writer
does not have a short position in the underlying stock or other instrument. If
the market price of the underlying falls below the strike price of the option,
the holder can exercise the put option and force the writer to buy the underlying
at the strike price for cash, profiting from the difference between the
market price and the option's strike price. But if the market price remains at
or above the strike price for the duration of the option, the option will expire
worthless and the writer will profit from the premium charged to the buyer for
the privilege of receiving the option.
Naked options are risky, but have the potential of being very rewarding.
If the stock price stays the same or slightly increases then the put option
seller profits and the option expires worthless. This type of strategy would
allow an investor the opportunity to buy stocks at a discount. However, if the
stock moves down, then the option premium increases, and it becomes more costly
to close the put position. The investor's total loss potential is limited
simply because the stock can not drop below zero.
Summary of Naked PUT Strategy
1. Write PUTs only when you are bullish on the stock, index, or market in general.
2. Select candidates whose underlying stock is in an up-trend or has a recent BUY signal.
3. Select candidates whose fundamental outlook is positive and getting better.
4. Generally, the time to maturity should be no more than 2 to 3 months.
5. Diversify your Portfolio with 4 or more different stocks.
6. Out of the money options are most often selected since "in the money" options
increase the probability of being exercised, even in a flat market.
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