Wednesday, April 22, 2009

Trading Lab Recap - Naked Puts

Selling Naked Puts
-Neutral to Bullish with High Implied Volatility
Structure: Sell a short term 4-6 week (higher rate of time decay) (less time for the stock to move against you), OTM (increase probability of profit) put option

When we buy options, we’re trying to predict where the market IS going to go. When we sell options (naked puts / calls) we’re trying to predict where the market ISN’T going to go!

If I sell a put, I obligate myself to buy the stock at the strike price. The person selling the put is essentially betting it’s not going to drop to the strike price.

Naked Put Example
USO @ $27.35
Sell to Open 26 put for $.90
Max Reward = .90
Theoretical Max Risk = $26 - .90 = $25.10
Breakeven = 26 - .90 = $25.10
Probability of Profit = 1 – delta (1 - .32 = .68) 68% prob of success
Margin Requirement?? 20-25% of stock price (5.40)
ROI = 90 / 540 = 16%

T1: Hold to expiry to realize max profit
T2: Buy To Close put when I’ve achieve 80% of max profit

Trade Management:
T1: Exit when stock breaks support
T2: Exit when stock reaches strike price
T3: I could ride to expiration & if the put is ITM, allow assignment- Go long shares of stock and sell covered calls
T4: Roll further OTM if stock breaks support or reaches strike (Sell 26 put, USO reaches 26 – buyback 26 put and sell 25 put)

Long Stock vs. Naked Put/Covered Call Combo
USO @ $27.35 Buy 100 shares – my risk is $27.35

Sell 26 put for $.90 - my risk is $25.10
At May expiration I go long 100 shares @ $25.10 cost basis
Sell June 26 call for $2
My new cost basis (after original naked put & covered call)
$23.10 (after a mere 3 ½ weeks)

Choosing Candidates:
Lower priced stocks ($30 or less)
Stocks I wouldn’t mind owning
Consider using ETF’s on Index or Sectors or Commodities

Choosing Strikes:
Sell OTM
Prob of profit > 80% ( sell delta of .20 or less)

Trades Reviewed
RUT @ $470
May 540 call - $2.68 Delta = .12
May 550 call - $1.83
Net Credit = $.85
Max Reward = $.85 (IF RUT is below 540)
Max risk =9.15 (IF RUT is above 550)
Exit the trade at around .15 or .20

XYZ @ $52
Bull Call Spread
July 50-55 call spread July 55 – 60 bull call spread
Buy 50 call 1 ITM
Sell 55 call 1 OTM
To realize max reward, I need XYZ to go up past $55


Anonymous said...

Tyler -

I have a question on the timing of entering the trade.

Would you enter the trade in the following scenario?

1. Earnings report coming out prior to the OPEX.
2. You got your charts and they are saying that stock has a heavy resistance at say say 105-110.
3. The credit for selling OTM Bear Call spread (110-115) comes out to satisfy your delta requirement, but it is possible that stock may run upto $100 and you maybe able to get higher credit for your spread.

would you wait for the stock to move to $100 and maybe wait till ER comes out, or just take the credit spread right now and hope by the time OPEX comes it will trade below $10105 (its resistance point).


you will just wait till ER comes out?

Tyler Craig said...


1. Would I wait until Earnings announcement comes out?

I usually stick with Indexes & ETF's, so earnings is never really a factor for me. In terms of my personal preference I don't really like the idea of putting on a directional trade into earnings.

2. Would I wait until the stock moves higher before placing a bear call spread (to receive a better credit).

For sure. Anytime I place a bear call spread I'm trying to place it as the stock is peaking at resistance and going back down. Thus, if I was of the opinion that the stock was going higher, then I would wait.


Anonymous said...

Thanks...It seems like indices is the way to go as it does not have the issue of takeovers/earnings or some such thing.