Don't hide the children or get excited, there is nothing to see here. A naked put is a put option contract where the option writer does not hold the underlying position. More precisely, we will be discussing a strategy called Cash Covered Puts.
An out-of-the-money put is sold for a net credit while setting aside cash equal to 100% of the exercisable value of the contract(s). Maximum profit is limited to the premium received. The maximum potential loss is substantial (premium received less the strike price).
Why use this strategy:
Traders may use this strategy when neutral to moderately bullish about a stock but would accept owning the stock at or below the put strike price.
First, let me start by letting you know that I am not a stockbroker and stock options involve a level of risk that should be thoroughly reviewed with your registered investment adviser or a broker-dealer and your tax accountant. As a matter of fact, before you can trade options you must be approved to do so by your brokerage institution and will be required to read Characteristics and Risks of Standardized Options which will provide you with extensive material to consider before buying or selling your first options contract. This discussion is for educational purposes only and not investment advice and will cover some of the basics of options and one of the strategies I have used over the last 30 years to enhance the returns on my portfolio. Specific securities are mentioned for informational purposes only and are not presented as investment advice.
In our previous discussion on options, we used some actual trades from my account on a stock with the ticker symbol RIOT. RIOT closely follows the price movement of Bitcoin and has been performing quite well as Bitcoin has had a nice move from a low of $3,858 this year to $28,580 as I write this December 30, 2020.
I use this strategy to purchase stocks I want to own at a predefined price. For RIOT, I had already purchased 1,000 shares for $4.36 in early August but wanted to acquire additional shares. On September 21, 2020, with the stock trading at $2.93 a share, rather than buying the underlying stock outright this time I sold someone the right to sell me 1,000 shares of the underlying RIOT stock for $3.00 a share before October 16, 2020. Remember each option's contract control 100 shares of the underlying stock, this means I sold 10 options contracts at a $3.00 strike price, and October 16, 2020, as the expiration date. I received $543.12 in proceeds from this trade.
The table above outlines the series of trades I made to demonstrate some of the flexibility that options provide. Between September 21, 2020, and November 9, 2020, the underlying RIOT stock price fluctuated between $2.35 and $4.26. Because our strike was $3.00, the stock moved in and out of the money or above or below our strike price. Again, if you have not read the previous options blog this may be a good time to review the components of an option premium. Time value and intrinsic value are both at play in this scenario.
As you can see from the table of my trades, I rolled the October puts into the next month at the same strike price for a small gain on October 1, 2020. Although closing the October puts only provided a gain of $22.76 (of the $543.12 possible), I received $813.12 for the November put contracts of the same strike price.
On a move up of the stock on October 14, 2020, I purchased 6 of the outstanding 10 contracts for a gain of $217.66 and purchased the remaining 4 contracts on November 9. 2020, to close out my entire position for an additional gain of $265.11. The total gain for this series of trades was $505.53. Had I not repurchased these options, I would not have had the stock put to me at expiration because it was well above my strike of $3.00. This would have resulted in a total gain of $835.88 across the series of trades discussed. RIOT closed at $5.99 on November 20, 2020, and continued to soar into the new year. On December 30, 2020, as I write this, the stock is trading at $18.04.