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Naked Put

Naked Put

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Published by Matthew Brown
This strategy profits if the stock price rises, remains steady, or if it only retraces slightly. If implemented and monitored correctly, it is a high probability strategy. However, there is also high Risk involved. This article discusses all aspects of this highly effective strategy.
This strategy profits if the stock price rises, remains steady, or if it only retraces slightly. If implemented and monitored correctly, it is a high probability strategy. However, there is also high Risk involved. This article discusses all aspects of this highly effective strategy.

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Published by: Matthew Brown on Oct 15, 2007
Copyright:Attribution Non-commercial

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10/07/2012

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Page 1 of 19
 © Copyright FMRAnalysts, 2007. All rights reserved.
Naked Put Strategy
 
Following is an outline on how to analyze stock/s to find a Naked Put position. This is a brief outline, and doesnot take into consideration your investment goals or personal Risk analysis.
 Action:
Selling (Writing) a Put option
 Expectation:
Stock/Market will be Neutral/Mildly Bullish
 Profit:
Limited to premium received
 Loss:
Unlimited, however stock price can only retrace to zero. If exercised, maximum loss is the strike priceminus the premium received
 Breakeven:
Strike price – premium received
 Index
 Description:...................................................................................................................................................2Strategy Outline ............................................................................................................................................2Margin..........................................................................................................................................................3 Naked Put Guidelines....................................................................................................................................4Analyzing for Naked Put positions................................................................................................................5Chart.........................................................................................................................................................5Fundamental Analysis ...............................................................................................................................8Market Analysis ........................................................................................................................................9Returns/Risk............................................................................................................................................11Placing Naked Put orders ............................................................................................................................14Exiting a Naked Put position.......................................................................................................................15 Naked Put Don’ts!.......................................................................................................................................17Resources....................................................................................................................................................18Disclaimer...................................................................................................................................................19
 
Page 2 of 19
 © Copyright FMRAnalysts, 2007. All rights reserved.
Description:
 
The writer (seller) of a put option is obliged to buy the underlying shares, at the exercise price. But only if thetaker (buyer) exercises the option. For accepting this obligation, the writer receives and keeps the option premium paid by the taker (buyer). This is whether or not the option is exercised.
Strategy Outline
 
The Naked Put strategy is one of the higher risk strategies. Profit potential is limited, while Risk (if unattended)can be unlimited. Due to this high risk, this strategy also has a correlation with high returns.It is a relatively simple strategy to understand. You
Sell to Open
a put option contract. If the option expires atthe end of its term, you profit from the position.It is a brilliant strategy if a few key guidelines are adhered to. But the complacent trader who does not respectthis strategy can lose far more than the money they put into the position.First, let’s recap what a Put option entails:
 The put option contract gives the Taker (buyer) the right to Sell their shares, at a set  price, on or before the expiration date. As the option writer (seller), you must buy shares if you are exercised, however, you receive premium from the taker for thecontract.
 You Sell the option, to receive premium. Because a majority of options expire, there is a
high probability
youwill not have to close the trade before expiration.If the share price is trading below the strike price of the option contract, there is a high probability you would be exercised, and forced to purchase shares. For this very important reason, we use the Strike price as our StopLoss Exit point. As Naked Put writers, we do not want to be exercised and forced to purchase shares (unlessthis is the reason you are entering the strategy – stock accumulation).FMR Analysts also places profit taking orders on this strategy. If we can close out of this strategy early, wewill.
 
Page 3 of 19
 © Copyright FMRAnalysts, 2007. All rights reserved.
A put option increases in value as the share price falls. It decreases in value as the share price rises. Because wewrite the position at the crust of Time Decay beginning to affect the option value, we also benefit as time drawscloser to the expiration date.After the position is written, we want the share price to remain steady or to rise in value. This will decrease thevalue of the put option. If we need to close the position, it will be cheaper for us to Buy to Close.Remember: we are selling the option before we buy it. Think of it as a “reverse trade”. First we sell the optionand receive the premium. We then buy the option and have to pay the premium. For this reason, it stands toreason that if we first sell it at a high price and then buy it back at a low price, we will profit from thedifference.The old saying “Buy low and Sell high” also applies here. Only we Sell first and Buy later.
Margin
 
“The seller of an option has the obligation to deliver the underlying of the option if it is exercised. To ensure hecan fulfil this obligation, he has to deposit collateral. This
premium margin
is equal to the premium that hewould need to pay to buy back the option and close out his position.”Reference:http://en.wikipedia.org/wiki/Margin_%28finance%29Because the Naked Put strategy does not own the stock, when you enter into the position your broker willrequire some “collateral” just in case the position shifts against you. We call this margin.Each broker has different specifications for how much margin is required, however, the following are someguidelines:
 ·
25% of the underlying market price + the premium - amount out of the money
OR 
 ·
10% of the underlying market price (or strike price for O-T-M puts) + the premium, whichever isgreater.The alternative to using margin for a Naked Put position is to ensure you have enough cash in your account tofully “cover” the position.For example;
 ·
You write (sell) 10 contracts on the 20.00 put option
 ·
To fully cover this position with cash (assuming US options), you will require 10 contracts x 100 shares per contract, x $20 = $20,000

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