Selling Naked Put

Someone asked me, "Isn't selling naked options very risky?".

The fact is, buying options is also risky, so is buying/selling shares, playing commodities, futures and forex. The main question should be, "Is it worth the risk and how can I manage the risk?"

I do not encourage any novice traders to sell naked Calls Options. With naked Put Options, it is a different matter. Due to the recent market turmoil, fresh opportunities arise. I have subscribe to to idea of selling naked Put (even to novice traders) provided traders follow certain strict rules. Selling naked Puts is a strategy used by Warren Buffet to collect shares of the stocks that he want to accumulate. Note that he accumulates stocks (a very long term investor) rather than trade stocks.

Selling Naked Put

This is how it works. Lets assume the following:

• Warren Buffet wants to accumulate more shares in BNI (he actually had bought BNI !).
• The shares is currently hovering around $55.
• He wants to buy more shares at $45 or below.

He could just place a buy stop order to buy the shares at $45. However, what he had done before was to sell the Put options, in this assumption, he would place an order to sell the $45 Put for say $6.00. If the share price drops below $45 by the time the options expired, he would have to buy the stock at $45. However, since he already sold the Put for $6, his actual cost of buying the additional shares is only $39 ($45 - $6). Whether it is wise to even buy the stock at $39 is another matter. What matters for him is that he has decided to accumulate more shares of the stock at $39.

If the above Put options expire worthless, he pocket all the $6 that he sold. Either way, he is happy with the transaction.

For novice traders, I have tweaked the above strategy further. I will be sharing the strategy to the next batch of my handholding sessions starting in May 2009. I will show them how to fish as well as giving some fish to start with. The strategy do not stop here. After collecting the shares, we must find ways to effectively maximise our returns. I would then share my trading style in playing the covered Calls. This set of strategies works best for those who want limited but decent profits with limited risk on a monthly basis. It does not require much monitoring - giving me time to invest more time on my Forex plays. When played well, each part of the strategies could generate more than 10% per month !

For March expiry options, I have played STP, selling $7.5 Put for $1.35 and selling $5 Put for $0.60 (played on different days). My $5 Put expired worthless (as such, I keep all the $0.60, a return of about 24% in less than a month, based on a margin of about $2.50).

My $7.5 Put expired in-the-money. As such, I was assigned with 100 shares for every option contract that I sold. However, my breakeven cost is $6.15 (the stock closed at $6.91 on Friday).

I would then play covered Calls on STP.

Cheers !

PersianCat (Millionaire-in-progress)


P.S.
As I write this posting, my intuition says that I should share this set of strategies in detail, separately to non-novice traders. Hmm.... We shall see .....