I wrote a couple of weeks ago about a Bear Market Rally, and although the Bear Trap has yet to be sprung, the time will come. When it does here’s a strategy you can use to boost your profits. The strategy is selling naked puts
I know, everyone thinks that selling naked options is very dangerous and risky, but if done right its no more risky than selling covered calls.
Selling puts is a strategy in which you get paid for agreeing to buy a specific stock at a specified price at a given time in the future. This idea works best in a down market where investors are scared and are willing to buy insurance for their stocks to guard against further losses. The best time to execute this strategy is when the VIX reaches the upper 30’s or higher. That is when the put option premiums are at their highest.
There are 3 things that can happen when you sell puts. The price of the stock goes up - you profit. The price of the stock goes no where - you profit again. Or the stock goes down and you have to buy the stock at the specified price, in this case you just bought the stock you wanted at a bargain price.
Lets take a look at an example: McDonalds (MCD) is currently trading around $57.50 but you’d like to buy it a little cheaper, you can sell a Dec $52.50 put option and collect a $2.35 premium per share or $235.00 per contract. Remember each option contract represents 100 shares of stock. So lets say MCD drops in price to less than $52.50 at option expiration. You will be obligated to purchase 100 shares of MCD for every option contract you sold. So your cost is $52.50 less the premium of $2.35 per share or $50.15/share. If MCD’s price rises, or stays the same or drops to a level not less than $52.50, then the option expires worthless and you get to keep the $235.00 premium. So as long as MCD remains above $50.15 you will be in profit. If you do end up having the stock put to you ( for this to happen MCD would have to fall almost 14.5%), then you can always turn around and sell a covered call against the stock and collect another premium and reduce your cost even more.
If your interested in this kind of trading you will need to check with your broker and be approved for option trading. Most brokers will allow you to sell puts on margin and put up only 20% of the trade amount. You can also do this trade in your IRA account but you will probably have to put up the full amount of the trade when the options are sold. The funds will be frozen and held till option expiration, so you won’t have these funds available for other trades.
You can find your own puts to sell by looking for safe companies that you’d like to own and then selling puts on them with a strike price that you’d like to pay for the stock. Don’t let fear hold you back you can get started by trying 1 option contract at a time until your more comfortable.
If you’d like to learn more about trading options check out Options University. and become a better investor. Or better yet get their Free Report “7 Deadly Mistakes People Make When Trading Options”
Good Investing
TC
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