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The selling of naked puts is a great way to open a second stream of income.

One usually sells a put option if one's outlook on the underlying security is bullish. The buyer of the put option pays the seller a premium for the right to sell the shares at an agreed-upon price. If the stock does not trade at or below the agreed-upon price (strike price, price) the seller gets to keep the premium.

Benefits associated with selling naked puts

  1. In essence, you get paid for entering a "limit order" for stock or stocks you would not mind owning.
  2. It allows one to generate income in a neutral or rising market.
  3. When one sells a naked put, in effect, one takes on the position of an insurance sales representative. One agrees to buy the stock in the future if it drops to a certain level before the option expires. For this, one is paid a premium upfront and if one repeats this strategy over and over again these premiums can really boost one's returns over time.
  4. Acquiring stocks via short puts is a widely used strategy by many retail traders and is considered to be one of the most conservative option strategies. This strategy is very similar to the covered call strategy.
  5. The safest option is to make sure the put is "cash secured." This simply means that you have enough cash in the account to purchase that specific stock at the agreed-upon price if the stock trades below the strike price. Actually, your final price would be a tad bit lower when you add the premium you were paid up front into the equation. For example, if you sold a put at a strike of 20 with two months of time left on it for $2.50, $250 per contract sold would be deposited in your account.
  6. Time is on your side. Every day you profit via time decay as long as the stock price does not drop significantly. In the event it does drop below the strike you sold the put at; you get to buy a stock you like at the price you wanted.
  7. Most options expire worthless so time is on your side. Time decay is the greatest in the front month, but the premium will not be as high as the puts that have more time them. However, this can be compensated for by repeating the strategy again and again. It involves more work but the potential gains one can lock in could make it worth the extra effort.

The majority of traders opt to close the put out prior to expiration if they have the chance of buying it back at much lower price. For example, selling the put at $2.50 and buying it back at $0.50.

Warning

This strategy should not be employed on speculative stocks. In other words, employ this strategy only on stocks you would not mind owning at a lower price.

Exelon Corp. (NYSE:EXC) is our play of choice to sell naked puts on for the following reasons:

  • A very strong levered free cash flow of $1.3 billion.
  • Annual EPS before NRI has increased from $4.12 in 2009 to $4.16 in 2011.
  • A good ROE of 19.45%.
  • A good operating margin of 23%.
  • A five year divided average of 4.03%.
  • A decent yield of 4%.
  • Even though net income has dropped slightly from $2.5 billion in 2010 to $2.49 billion in 2011, it still generates huge amount cash flow, which is more than enough to cover the dividend payments.
  • A 5 year cash flow average of $7.72.
  • A good five-year dividend growth rate of 23.6%.
  • A free cash flow yield of 3.24%.
  • A quarterly earnings growth rate of 15.6%.
  • An acceptable current ratio of 1.1.
  • An excellent interest coverage ratio of 159.
  • A good payout ratio of 51% and great five-year average payout ratio of 49%.
  • An incredible long dividend history; it has been paying dividends since 1902.
  • 100K invested for 10 years would have grown to 201k.

Suggested strategy for selling naked puts on Exelon Corp.

Exelon just moved higher after putting in a series of new 52-week lows. It is now rather oversold, and if you are bullish on this stock it would be a good time to sell naked puts. Our advice is for investors to wait for it to test the 37.50-38.00 ranges again before selling puts. The Oct 35 2012 calls are trading in the 1.30-1.145 ranges. Exelon closed at $38.59 today so if it were to pull back to the 37.50-38.00 ranges the put should rise in value by $0.50- $0.75. We will assume an increase of 40 cents only so the option price would move from $1.40 to $1.80. If you sold the option at this time, $180 would be deposited in your account per contract.

If Exelon does not trade below 35, you get to keep the premium, which would translate into a gain of 5.14%. If it trades below 35, you will be assigned shares at a price you would have been happy to pay for the stock. Actually, your price is even lower after you subtract the premium. In this example, your final cost would be $33.20 (35-1.80). In essence you are getting paid to wait.

One could adjust this strategy, and sell puts with different strike prices if Exelon pulls back to the 37.50-38.00 ranges you could sell puts with strikes ranging from 33-36.

If you are bullish on this stock at current prices, then you could sell puts immediately instead of waiting for a pullback.

Company: Exelon Corp

Levered Free Cash Flow = $1.38B

Basic Key ratios

  1. Percentage Held by Insiders = 0.09
  2. Relative Strength 52 weeks = 54
  3. Dividend 5-year Growth = 23%
  4. Cash Flow 5 -year Average = 7.72
  5. Dividend Yield 5-Year Average = 4.03

Growth

  1. Net Income ($mil) 12/2011 = 2495
  2. Net Income ($mil) 12/2010 = 2563
  3. Net Income ($mil) 12/2009 = 2707
  1. EBITDA ($mil) 12/2011 = 6982
  2. EBITDA ($mil) 12/2010 = 7981
  3. EBITDA ($mil) 12/2009 = 7751
  1. Annual Net Income this Yr/ Net Income last Yr = -2.65
  2. Cash Flow ($/share) 12/2011 = 7.64
  3. Cash Flow ($/share) 12/2010 = 8.42
  4. Cash Flow ($/share) 12/2009 = 8.07
  1. Sales ($mil) 12/2011 = 19184
  2. Sales ($mil) 12/2010 = 18644
  3. Sales ($mil) 12/2009 = 17318
  1. Annual EPS before NRI 12/2007 = 4.31
  2. Annual EPS before NRI 12/2008 = 4.17
  3. Annual EPS before NRI 12/2009 = 4.12
  4. Annual EPS before NRI 12/2010 = 3.95
  5. Annual EPS before NRI 12/2011 = 4.16

Dividend history

  1. Dividend Yield = 4.00%
  2. Dividend Yield 5 Year Average 12/2011 = 4.03
  3. Dividend Yield 5 Year Average 09/2011 = 4.03
  4. Annual Dividend 12/2011 = 2.1
  5. Annual Dividend 12/2010 = 2.1
  6. Forward Yield = 5.54
  7. Dividend 5 year Growth = 23%

Dividend sustainability

  1. Payout Ratio 06/2011 = 0.51
  2. Payout Ratio 5 Year Average 12/2011 = 0.49
  3. Payout Ratio 5 Year Average 09/2011 = 0.49
  4. Payout Ratio 5 Year Average 06/2011 = 0.49
  5. Change in Payout Ratio = 0.01

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -10.71
  2. EPS Growth Quarterly(1)/Q(-3) = 129.92
  3. ROE 5 Year Average 09/2011 = 23.37
  4. Return on Investment 06/2011 = 10.4
  5. Debt/Total Cap 5 Year Average 12/2011 = 49.63
  6. Current Ratio 06/2011 = 1.1
  7. Current Ratio 5 Year Average = 1.2
  8. Quick Ratio = 0.93
  9. Cash Ratio = 0.4
  10. Interest Coverage = 159

Company: China Life Insurance (NYSE:LFC)

Basic Key ratios

  1. Relative Strength 52 weeks = 31
  2. Dividend 5-year Growth = 30.35
  3. Cash Flow 5 -year Average = 10.5
  4. Dividend Yield 5-Year Average = 1.41

Growth

  1. Net Income ($mil) 12/2011 = 2866
  2. Net Income ($mil) 12/2010 = 5001
  3. Net Income ($mil) 12/2009 = 4843
  1. EBITDA ($mil) 12/2011 = 3476
  2. EBITDA ($mil) 12/2010 = 6331
  3. EBITDA ($mil) 12/2009 = 6350
  1. Cash Flow ($/share) 12/2011 = 6.46
  2. Cash Flow ($/share) 12/2010 = 10.57
  3. Cash Flow ($/share) 12/2009 = 10.25
  1. Sales ($mil) 12/2011 = 60115
  2. Sales ($mil) 12/2010 = 57104
  3. Sales ($mil) 12/2009 = 50076
  1. Annual EPS before NRI 12/2009 = 2.57
  2. Annual EPS before NRI 12/2010 = 2.7
  3. Annual EPS before NRI 12/2011 = 1.55

Dividend history

  1. Dividend Yield = 2.06
  2. Dividend Yield 5 Year Average 12/2011 = 1.41
  3. Annual Dividend 12/2011 = 0.81
  4. Forward Yield = 1.2
  5. Dividend 5 year Growth 12/2011 = 30.35

Dividend sustainability

  1. Payout Ratio 5 Year Average 12/2011 = 1.28

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -33.61
  2. Next 3-5 Year Estimate EPS Growth rate = 24.38
  3. EPS Growth Quarterly(1)/Q(-3) = 178.13
  4. ROE 5 Year Average 12/2011 = 18.36
  5. Debt/Total Cap 5 Year Average 12/2011 = 1.51
  1. Current Ratio 06/2011 = 0.52
  2. Current Ratio 5 Year Average = 4.08
  3. Quick Ratio = 0.52
  4. Cash Ratio = 0.45
  5. Interest Coverage Quarterly = N/A

Valuation

  1. Book Value Quarterly = 60.42
  2. Price/ Book = 0.65
  3. Price/ Cash Flow = 6.1
  4. EV/EBITDA 12 Mo = -18.87

Company: Pitney Bowes Inc (NYSE:PBI)

Basic Key ratios

  1. Percentage Held by Insiders = 0.26
  2. Relative Strength 52 weeks = 29
  3. Dividend 5-year Growth = 2.5
  4. Cash Flow 5 -year Average = 4.28
  5. Dividend Yield 5-Year Average = 5.67

Growth

  1. Net Income ($mil) 12/2011 = 617
  2. Net Income ($mil) 12/2010 = 292
  3. Net Income ($mil) 12/2009 = 423
  1. EBITDA ($mil) 12/2011 = 817
  2. EBITDA ($mil) 12/2010 = 838
  3. EBITDA ($mil) 12/2009 = 1032
  1. Cash Flow ($/share) 12/2011 = 4.31
  2. Cash Flow ($/share) 12/2010 = 3.76
  3. Cash Flow ($/share) 12/2009 = 3.92
  1. Sales ($mil) 12/2011 = 5278
  2. Sales ($mil) 12/2010 = 5425
  3. Sales ($mil) 12/2009 = 5569
  1. Annual EPS before NRI 12/2009 = 2.28
  2. Annual EPS before NRI 12/2010 = 2.23
  3. Annual EPS before NRI 12/2011 = 2.26

Dividend history

  1. Dividend Yield = 8.79
  2. Dividend Yield 5 Year Average 12/2011 = 5.67
  3. Annual Dividend 12/2011 = 1.48
  4. Forward Yield = 8.79
  5. Dividend 5 year Growth 12/2011 = 2.5
  1. Dividend sustainability
  2. Payout Ratio 06/2011 = 0.63
  3. Payout Ratio 5 Year Average 12/2011 = 0.58
  4. Change in Payout Ratio = 0.05
  1. Performance
  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -36.12
  2. EPS Growth Quarterly(1)/Q(-3) = -115.09
  3. ROE 5 Year Average 06/2011 = 674.81
  4. Return on Investment 06/2011 = 11.1
  1. Current Ratio 06/2011 = 1.05
  2. Current Ratio 5 Year Average = 1.09
  3. Quick Ratio = 1
  4. Cash Ratio = 0.36
  5. Interest Coverage Quarterly = N/A

Company: Nexen Inc. (NXY)

Levered Free Cash Flow = 1.25B

Basic Key ratios

  1. Percentage Held by Insiders = 0.17

Growth

  1. Net Income ($mil) 12/2011 = 705
  2. Net Income ($mil) 12/2010 = 1162
  3. Net Income ($mil) 12/2009 = 489
  4. 12months Net Income this Quarterly/12 months Net Income 4Q's ago = -31.68
  5. Quarterly Net Income this Quarterly/same Quarter year ago = -79.81
  1. EBITDA ($mil) 12/2011 = 3680
  2. EBITDA ($mil) 12/2010 = 3008
  3. EBITDA ($mil) 12/2009 = 993
  4. Net Income Reported Quarterlytr ($mil) = 43
  5. Annual Net Income this Yr/ Net Income last Yr = -39.31
  6. Cash Flow ($/share) 12/2011 = 5.19
  7. Cash Flow ($/share) 12/2010 = 4.13
  8. Cash Flow ($/share) 12/2009 = 0.98
  1. Sales ($mil) 12/2011 = 6483
  2. Sales ($mil) 12/2010 = 5657
  3. Sales ($mil) 12/2009 = 5556
  1. Annual EPS before NRI 12/2007 = 2.46
  2. Annual EPS before NRI 12/2008 = 3.55
  3. Annual EPS before NRI 12/2009 = 0.97
  4. Annual EPS before NRI 12/2010 = 1.05
  5. Annual EPS before NRI 12/2011 = 1.47

Dividend history

  1. Dividend Yield = 1.00
  2. Dividend Yield 5 Year Average =0.8%
  3. Annual Dividend 12/2011 = 0.2
  4. Forward Yield = 1.07
  5. 5 year dividend growth rate= 21.7%
  1. Dividend sustainability
  1. Payout Ratio 06/2011 = 0.14
  2. Payout Ratio 5 Year Average 06/2011 = 0.11
  3. Change in Payout Ratio = 0.03

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -28.15
  2. Next 3-5 Year Estimate EPS Growth rate = 7
  3. EPS Growth Quarterly(1)/Q(-3) = -170
  4. ROE 5 Year Average 06/2011 = 17.26
  5. Return on Investment 06/2011 = 6.3
  6. Debt/Total Cap 5 Year Average 06/2011 = 43.63
  1. Current Ratio 06/2011 = 1.08
  2. Current Ratio 5 Year Average = 1.36
  3. Quick Ratio = 0.98
  4. Cash Ratio = 0.33
  5. Interest Coverage =7.9

Company: New Gold Inc (NYSEMKT:NGD)

Basic Key ratios

  1. Relative Strength 52 weeks = 52
  2. Cash Flow 5 -year Average = -0.11
  3. Dividend Yield 5-Year Average = 0

Growth

  1. Net Income ($mil) 12/2011 = 179
  2. Net Income ($mil) 12/2010 = 182
  3. Net Income ($mil) 12/2009 = -194
  1. EBITDA ($mil) 12/2011 = 335
  2. EBITDA ($mil) 12/2010 = 261
  3. EBITDA ($mil) 12/2009 = -106
  1. Cash Flow ($/share) 12/2011 = 0.59
  2. Cash Flow ($/share) 12/2010 = 0.49
  3. Cash Flow ($/share) 12/2009 = 0.16
  1. Sales ($mil) 12/2011 = 696
  2. Sales ($mil) 12/2010 = 530
  3. Sales ($mil) 12/2009 = 324
  1. Annual EPS before NRI 12/2009 = 0
  2. Annual EPS before NRI 12/2010 = 0.29
  3. Annual EPS before NRI 12/2011 = 0.43

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -11.6
  2. Next 3-5 Year Estimate EPS Growth rate = 5
  3. EPS Growth Quarterly(1)/Q(-3) = 125
  4. ROE 5 Year Average 12/2011 = -2.14
  5. Return on Investment 06/2011 = 8.43
  6. Debt/Total Cap 5 Year Average 12/2011 = 12.68
  1. Current Ratio 06/2011 = 2.07
  2. Current Ratio 5 Year Average = 3.65
  3. Quick Ratio = 1.59
  4. Cash Ratio = 1.42
  5. Interest Coverage Quarterly = N/A

Conclusion

On all the suggested candidates, one could do even better if one waited for the markets to pull back strongly before selling a naked put. First of all, the put premiums will rise due to the "fear factor" and if assigned the shares you would end up getting in at a mouth watering price.

Disclaimer

This list of stocks is meant to serve as a starting point. Please do not treat this as a buying list. It is imperative that you do your due diligence and then determine if any of the above plays meet with your risk tolerance levels. The Latin maxim caveat emptor applies - let the buyer beware.

Source: Exelon Among 5 Interesting Candidates For Selling Naked Puts

Additional disclosure: EPS, EPS surprise, broker recommendations, and price and consensus charts sourced from zacks.com. A significant portion of the historic data was obtained from zacks.com. Option table sourced from yahoofinance.com. Consensus estimate tables sourced from reuters.com.