What Is a Naked Put?
Let me tell you directly: a naked put is an options strategy where you, as the investor, write or sell put options without holding a short position in the underlying security. You might hear it called an uncovered put or a short put, and if you're selling one, you're known as a naked writer.
The main reason to use this strategy is to grab the option's premium when you forecast the underlying security will go higher, but it's one you'd be okay owning for at least a month or longer if things don't go as planned.
Key Takeaways
- A naked put means selling a put option uncovered, without any offsetting positions.
- You benefit as the seller when the underlying security's price goes up.
- This strategy has limited upside profit but theoretically unlimited downside loss from the current price down to zero.
- Your breakeven point as the writer is the strike price plus the premium you received.
How a Naked Put Works
You execute a naked put assuming the underlying security will fluctuate but generally rise over the next month or so. To do this, you sell a put option without a corresponding short position in your account. This makes the option uncovered, meaning you have no position to fulfill the contract if the buyer exercises it.
Since put options profit from a falling security price, if the price actually rises, the naked put doesn't hurt you—the option's value drops to zero, and you keep the premium you got for selling it.
As the seller, you want the security to rise so you profit from the premium. But if it falls, you might have to buy the stock if the buyer exercises the option. That's why you should only use this on securities you view favorably—if you end up owning it, you won't mind holding it for at least a month.
Naked Put vs. Covered Put
Contrast this with a covered put strategy, where you hold a short position in the underlying security for the put option. You short the security and sell the puts in equal quantities.
A covered put functions much like a covered call, but you profit from a mildly declining security price instead of a rising one. The key difference is the short underlying position and selling puts rather than calls.
Special Considerations
Be aware that a naked put is inherently risky with limited upside and theoretically significant downside loss. You achieve maximum profit only if the underlying closes at or above the strike at expiration—further rises don't add more profit.
The maximum loss could be huge since the security's price can drop to zero, and a higher strike means higher potential loss. In practice, though, you'd likely buy back the option before it falls too far below the strike, based on your risk tolerance and stop-loss.
Using Naked Puts
Due to the risks, only experienced options investors should write naked puts. Margin requirements are high because of the potential for big losses.
If you firmly believe the underlying stock will rise or stay the same, you can write puts to earn the premium. If it stays above the strike until expiration, you keep the full premium minus commissions.
But if the stock falls below the strike by expiration, the buyer can force you to take delivery of the shares. You'd buy them at the strike price, even if the market price is lower—for example, with a $60 strike and $55 market, you lose $5 per share. The premium offsets some loss, but it can still be substantial. Your breakeven is the strike minus the premium, giving you a bit of cushion.
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