What is Naked Put Selling?
Some people may have heard about a strategy called selling naked puts. The first thing they think is, oh that has to do with stock options it must be risky. Others who know this strategy love it and utilize it frequently.
So what exactly are naked puts and are they dangerous. Well when you sell a put you are giving someone else the right to sell a stock at a certain price before an expiration date. For exampe if you sell the $30 put on stock XYZ you would get some money up front, but you would also be obligated to buy the stock at $30 should the buyer of the option decided to exercise their right.
This means that if the stock drops all the way to $0 you could be forced to buy a worthless stock for $30.
That means selling puts can absolutely be a risky strategy. In fact this is one of the only strategies in the stock market that you have the potential to lose more money on one trade then you even have in your account.
So, why do people like me still use this strategy? Well if used properly it can actually be safer than buying a stock.
Let me explain; say I find a stock that is trading at $40. It is a dividend paying stock and is a very strong company. I could always get into the position and risk $40 or instead I can sell the $35 put make and $3 up front, this way I would not be obligated to buy it unless it dips below $35.
The great thing is that as long as I keep enough cash lying around to get into the position if I have to, the only thing I am risking is getting into a position I already wanted to get into. If I bought the stock and then it goes down to around $34 I would lose $6. But if I sold the put and it goes down to $34 I would have to buy it at $35 losing $1, but because I sold the put for $3 I would actually be up $2.
The thing I really like about this method is that it can work great with other investment strategies like covered call writing, as long as the stock is something that will likely go up in the long term.
