Another newbie needs help!

Discussion in 'Options' started by Little Nickey, May 24, 2001.

  1. If I sell a naked put... say WXYZ is @ 55.00 and I sell the 60 put and recieve 7.50. If at the time of expiration the stock is @ 56.50 (or somewhere in the money)I will get the stock put to me right? So, when the stock is put to me can I immedately sell it or is there some holding rule that I have not read about yet? I am thinking that if the stock is put to me and I sell before it dropps past 52.50 (60 - the 7.5 premium) then I will be profitable. It is also to my understanding that if the price of the stock is over the 60 strike then the option would be worthless, so there is no risk of being forced to exercise my position. Am I doing this right?
  2. Yes, you are correct in your assessment. If the stock closes at expiration below 60 you will be assigned, and can sell the stock right back out after it's been put to you with no restrictions. You could even short the stock before expiration, and when it's put to you that would cover your short.

    However, if you really didn't want to own the stock to begin with, your best bet is to simply close your option position right before the close of expiration day (only if the position is in the money). So for instance in your example, if the stock was at 56 going into the close of expiration day, your 60 put would be worth $4, which you could simply buy back before the close and pocket the $3.50 per contract in profit, which is exactly the same you would make if you had the stock put to you at 60 and sold it on Monday at 56.

    If of course, your put is at or out of the money, simply do nothing and let the option expire worthless, letting you pocket the entire premium as pure profit.
  3. I seems like I am always hearing about how risky selling puts is. This doesn't seem risky at all (if you pay close attention, especially at the time of expiration). Am I missing something?

  4. The only risk involved is the stock closing below your break even point (the strike price of the put minus the premium), which would give you a losing position. If something terrible happens to the stock, and its share price plummets, that is where the real risk is. So if a stock is at 65 and you've sold a 60 put, and due to news, market events, etc. the stock plunges to 30, you'll be sitting with a put that you would either have to buy back for a 30+ point loss or have stock put to you at 60 when the stock is currently trading at 30. Either way it comes out the same.

    That said, selling naked puts is no riskier than actually being long a stock that you buy and hold. Likewise, selling naked calls is no riskier than being short a stock. There is always the risk of the price going against you, but either way, it you want to you can always bail out by closing your option position. So to answer your question, naked options aren't any riskier than being long or short the stock itself, assuming you still maintain stop loss management if the trade goes clearly against you.
  5. OK, I understand what you mean now. Thanks again.
  6. I'll add something to. Ok so you took a 30 point loss with the above situation. The additional thing to think about is options provide a huge amount of leverage. So a 30 point loss is magintude by 100 times. That hurts.

    The other thing is if a stock drops 30 points volatility heavily increases, so in addition to the 30 point loss, the leverage is another factor figured into a price of the option, the volatility. This will add another 10% or more to your loss.

  7. That does sound dangerous!
  8. Relax LN. There should be clarification about the leverage issue on a naked position. In the example I laid out, a stock trading at 60 lost 30 points of value, which means that the put option rose at least 30 points in value. Since each contract represents 100 shares of stock, how would the loss on 1 put contract be any different than if you owned 100 shrares of the underlying stock? I know about added volatility value, but assuming you hold your option and are assigned, the volatility isn't a factor, since at expiration the option will be exactly worth the strike price minus the stock price.

    When I say that there is no more risk to selling naked options to actually owning or shorting the underlying stock, it is assumed that one does not sell more contracts than he or she has cash in their account to purchase the stock itself in a worst case scenario. So in other words, if you sell 3 put contracts with a 60 strike, you need to have at least $18K in cash (or margin if you're willing to own stock on margin) to keep yourself from getting in too deep. I guess what rtharp was referring to was if you sold, let's say 10 put contracts but only had half the money in your account to buy the actual stock if you were assigned. In that case, yes, you would be in deep water. But as long as you sell a proportionate number of contracts to what your account can handle if assigned, you'll be fine.