Is Selling Naked Puts Dangerous?
Selling puts is a fantastic technique that can help increase your overall returns in the stock market. But how safe is this strategy? Aren’t stock options very risky after all?
When you buy stock options you are betting the stock will make a large move fast. But when you sell puts the right way you are actually taking on less of a risk then you would have if you had decided to simply buy the stock. So, how can this possibly be?
Well let’s look at this strategy. When you sell a put you are giving someone else the right to sell you a stock at a certain strike price. You do get to walk away with a nice option premium to take on this risk.
So say you sold the $45 put option on a stock you you would walk away with the premium and only be obligated to buy it if it closes below $45 by the time the option expires.
If this stock closes at $48 or even $46 you are still not going to be obligated to buy the stock. Instead you are simply going to be able to walk away with the premium that you sold. Hey it is free money!
Now let’s look at what happens if the stock goes below this level. If the stock closes at $30 then you will be obligated to buy it at $45 taking a huge loss.
In fact your max loss would be $45. So it could potentially mean that you lose a large sum of money. So why do I still love to sell puts? The strategy can work extremely well provided two things.
1. You do not mind getting into the stock
I would never sell a put on a stock which I would not love to own. In other words if I would love to hold onto the stock for the long term I might consider selling a put on it instead.
This way even if I get called out the only thing that happened was that I got into a position that I wanted to get into anyways. I would also do much better than if I were to simply buy the stock because I would get money up front.
2. Can Afford to Buy the stock
Of course if you can’t afford to buy the stock you are taking a large risk. What if the stock goes down to $20 or lower? You would simply have to take the loss possibly even wiping your account out.
I personally love this strategy, especially when I sell options on dividend paying stocks which also have terrific fundamentals. It isn’t for everyone but I love it because it gives be a win or win situation. I either walk away with the premium from the option, or I get into a great stock which I do not mind owning for a little while.
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Tags: put options