Ross, there is a major difference between naked puts and naked calls.
With naked calls your potential loss is infinite because there is no limit as to how high a stock can go, but with naked puts your potential loss is limited because a stock can't go below zero. If you sell a March 60 today for say $25 you are obligated to pay $60 in March (unless the stock is above $60, in which case you keep the premium). Since you have $25 in hand, your potential loss is $35/share (or $3500 per contract) if the stock goes all the way to zero. If you buy the stock today at $36 your potential loss is virtually the same. If the stock goes to zero, you lose $36/share.
Thus the downside risks of selling a deep in the money naked put and the downside of owning the stock are virtually identical. There are two important differences however. One, instead of parting with cash, you recieve it (until March). Two, if the stock goes above $60 you get no additional benefit. In fact if the stock goes above $60 before expiration the put will continue to have value until expiration.
I think that the thing I need to clarify for the novice is that when you recieve the cash from selling the puts, you can't spend it. You must leave it in the account along with other cash in the form of a reserve requirement. After all, you have an obligation to buy the stock at $60/share in March. The security firm needs to be sure that you will be in a position to do so. This reserve requirement continues all the way to expiration, by the way. The amount of reserve required does decrease as the stock goes up, but I can't tell you the exact formula. Even if the stock goes above $60, there is still a reserve requirement.
All in all, though, writing naked puts is risky, but no more risky than buying the underlying stock. Just be sure that you are really prepared to buy the stock at the strike price at expiration, and you should be fine. Also, don't be tempted by the power of leverage to sell more puts than you are prepared to buy stock.
As for writing naked calls, be aware that your potential loss is unlimited. The same goes for shorting a stock, by the way.
Good luck,
Carl |
