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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.

 

Market Opinion

 

Bullish.

 

P/L

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When To Use

 

Use this strategy for income, allowing you to earn income as the stock rises.

 

Example

 

XXXX is trading at $27.35 on May 10, 2011.

Sell the June 2011 $25.00 strike put for $1.05.

 

Benefit

 

If the stock does rise as expected, then you gain income from that move.

 

Risk vs. Reward

 

The risk is put strike price minus the premium. The reward is the premium you receive for the option.

 

Net Upside

 

The premium you receive for the put.

 

Net Downside

 

Loss potential is limited because the stock can not drop below zero.

 

Break Even Point

 

Put strike minus put premium.

 

Effect Of Volatility

 

Effect Of Time Decay

 

Positive. Especially if you sell the put a month before expiration.

 

Alternatives Before Expiration

 

To stem a loss, if the stock drops below stop loss, close out the position by buying back the puts.

 

Alternatives After Expiration

 

At expiration, the sold option is worthless and you keep the premium.

 

 

 

 

 

 

         

 
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