Mark:
Naked puts have been a gold mine for me so far. I have already done it once with FEET as well as other stocks. Example: stock price drops to 14 1/2 on earnings announcement; March 1998 put for strike price 15 sells for 3 1/2. I sell the naked put and immediately get $3,500 in my account for 10 contracts. My broker (Waterhouse) requires that I have 1/4 of the strike price (or $5,000, whichever is more) in my account in cash in addition to the $3,500 that comes in as a result of the sale. Thus, I must keep $5,000 cash plus the $3,500 option income in the account. This is $8,500 of the potential cost of $15,000 for taking delivery of the stock eventually.
If the stock begins to rise, the price of the option decreases. Say the stock goes to 17 and the option price drops to 2. I could buy it back for $2,000 and keep the $1,500 difference. The $5,000 being held (plus the $1,500 profit) is then released for other uses. If the stock goes to 20, the option might drop to 1/2 or so and I could buy it back for $500 and keep $3,000 profit.
If the stock goes down, there are two possibilities, each with two sub-choices.
(1) Stock goes down a little, say to 13 and the option price rises to 4 1/4. First possibility: I buy back the contracts at a $750 loss (plus commissions) and am free; second possibility: I wait until expiration and take delivery of the stock at an effective price of 11.5 even though it is at 14 (11.5 is the 15 strike price minus the 3.5 received from the option contract).
(2) Stock goes down a lot, say to 11. First possibility: I buy back the contracts at 5 1/4, taking a $1,750 loss (plus commissions) and am free; second possibility: I take delivery of the stock at the effective price of 11.5, thus suffering a paper loss of $500 which could be wiped out if the stock goes back up.
The beauty of it is the stock has to go below 11.5 before you get in trouble and you can always bail before that unless it freefalls to that level. If you wait until after earnings, the chances of such a fall are minimal. If the stock stays below 15, you have the option of taking delivery at an effective price of 11.5! How could you ever buy the stock that cheap on the open market?
I did this with WDC, selling for $4,500 and buying back for $1,500. If you work with the longer term options (March 1998 right now), you have flexibility and don't get in trouble quickly. Naked puts are bullish because you profit if the stock goes up. Sometimes people get confused because it involves puts and think that this is a bearish activity.
P.S. Waterhouse also requires a minimum account equity of $25,000 to do this stuff.
Walter High |
