Tuesday, January 5, 2010

Mail Time- Naked Puts vs. Put Spreads

I received the following question a few days back via e-mail.

When would you sell naked puts vs. put spreads?

I tackled a similar question back in an April Mail Time post, so I'm going to draw today's response largely from there. The first consideration is the price of the underlying. I typically only sell naked puts on stocks around $40 or below. If it's a higher priced stock I'll simply sell a put spread to limit risk and margin required. For example, I would never ever sell a naked put on the RUT or SPX as it would tie up way too much capital and involve an exorbitant amount of risk. The one exception to my usual price parameters has been the occasional times I've sold puts on GLD. Most recently I was short the Jan 102 and 103 puts. My primary rationale for not selling spreads even though it was a $100+ stock was I didn't need the additional capital that was tied up in margin and I was a willing buyer of gold around the 100 level.
[Source: EduTrader]

The other consideration may be a traders outlook on implied volatility. While selling puts outright is more of a pure short volatility play, selling put spreads is a hedged volatility play (since you're both long and short options). So your position vega will obviously be higher with the naked put compared to the put spread.
[Source: EduTrader]

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