Selling Naked Puts

Naked Put Strategy Characteristics

Favorable Direction: Bullish

Maximum Risk: Unlimited

Maximum  Reward: Unlimited (till the Underlying security reaches zero)

Payoff Chart: 

A PUT is an option to sell a stock at a predetermined price.  When you are SELLING a PUT, you are telling the BUYER of the PUT that you will allow him to SELL the Stock to you at a pre-determined piice (the Strike Price).

Example:

You are bullish on Tata Motors which is currently trading at Rs. 248.  The February 240 Strike PUT (Expiration Feb 23) is being quoted at an average price of Rs. 7.70.  This means that potential buyers of the PUT are hoping that Tata Motors drops to 240-7.7 or Rs. 232.30 to breakeven or below to make a profit by Feb 23rd.  If you are bullish on Tata Motors, you can sell this PUT to the buyer.  

Scenario 1: The stock stays above 240 on Feb 23. The PUT option expires worthless and you keep the entire premium of Rs. 7.70.

Scenario 2:  The stock settles at 230 on Feb 23.  The PUT option you sold for Rs. 7.70 is now worth Rs. 10 that you have to buy back which means there is a loss to you of Rs. 2.30. Alternatively, you can chose to buy the Stock at Rs. 240 for your portfolio.

Scenario 3: The stock settles at 235 on Feb 23.  The PUT option you sold for Rs. 7.70 is now worth Rs. 5 that you have to buy back. This means a profit of Rs. 2.70 / contract to you.

Selling a put is a short-term income strategy.  You have to manage the PUT position carefully as any unexpected bad news or a drop in Stock price can result in huge losses.