Selling naked puts is a great way to purchase shares in companies you like at a predetermined price. In essence, you are getting paid to put in a "limit order."
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 a stock or stocks you would not mind owning.
2. It allows one to generate income in a neutral or rising market.
3. When you sell a naked put you are in a way acting like an insurance agent. The seller of the option agrees to buy the stock in the future if it drops to a certain level before the option expires. For this, you (the seller) are paid a premium upfront. If this strategy is repeated over and over again these premiums can really help boost your 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 if it trades below the strike price. 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 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.
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
This strategy should not be employed on speculative stocks or stocks that have weak fundamentals and or the technical picture is weak. In other words, this strategy should only be employed if you really want to own the stock but want to purchase it at a lower price.
Reaons to be bullish on Denbury Resources (NYSE:DNR)
- Net income increased from $-75 million in 2009 to $573 in 2011
- EBITDA increased from $171 million in 2009 to $1.5 billion in 2011
- Sales surged from $889 million in 2009 to $2.3 billion in 2011
- Annual EPS before NRI increased from $0.7 in 2009 to $1.43 in 2011
- It has a projected 3-5 year EPS growth rate of 40%
- A good five year average ROE of 14%
- A good interest coverage ratio of 3.2
- A strong five year sales growth rate of 22%
- A good long-term debt to equity ratio of 0.56
- A strong quarterly revenue growth rate of 25%
- Year over year growth rate for 2012 of 16%
- $100K invested for 10 years would have grown to $606K
Naked put strategy for Denbury Resources Inc
DNR has pulled back nicely from a high of 21.37 over the past few weeks. As stocks have a tendency to overshoot to the downside (and upside) we would implement the following strategy. The charts are indicating that DNR could test the 14 ranges where it has a fairly strong degree of support. Investors should divide the money they are going to invest in this play into 2-3 lots and only deploy one lot when DNR test the $16 ranges.
DNR is currently trading at 17.50, so a pullback to the 16 ranges could/should drive the value of the Sept. 14 puts as high as 85 cents. For this example, we will assume that when DNR is trades in the 16 ranges, the puts can be sold for 75 cents. The moment the puts are sold $75 per contract will be deposited in your account. If the stock trades below 14, then you will be assigned the shares, your final price will work out to 13.25 (14- 0.75). If the stock does not trade below 14, then you get to keep the premium which based on today's stock price works out to a gain of 4.28%.
Part II of the strategy.
If the stock breaks below 14 on a weekly basis there is a very good chance that it could trade down to the 11-12 ranges before a bottom is in place. At this point, you can deploy another lot, and sell puts with strikes in the 11-12 ranges. If you happen to have enough money to have three lots, then you can go for a long shot play. Sell the puts with a strike at or below 10 when DNR trades in the 11-12 ranges. Denbury Resources was reviewed in detail in our recent article 3 Dividend And 2 Interesting Growth Plays To Consider.
Other interesting stocks
Investors looking for other ideas or stocks to sell puts on might find the detailed information we have provided on four additional stocks to be of interest.
Company: Nexen Inc (NXY)
Levered Free Cash Flow = 1.25B
- Net Income ($mil) 12/2011 = 705
- Net Income ($mil) 12/2010 = 1162
- Net Income ($mil) 12/2009 = 489
- Cash Flow ($/share) 12/2011 = 5.19
- Cash Flow ($/share) 12/2010 = 4.13
- Cash Flow ($/share) 12/2009 = 0.98
- Sales ($mil) 12/2011 = 6483
- Sales ($mil) 12/2010 = 5657
- Sales ($mil) 12/2009 = 5556
- Annual EPS before NRI 12/2009 = 0.97
- Annual EPS before NRI 12/2010 = 1.05
- Annual EPS before NRI 12/2011 = 1.47
- Dividend Yield = 1.2
- Dividend Yield 5 Year Average =0.8%
- 5 year dividend growth rate= 21.7%
- Payout Ratio 06/2011 = 0.14
- Payout Ratio 5 Year Average 06/2011 = 0.11
- Next 3-5 Year Estimate EPS Growth rate = 7
- EPS Growth Quarterly(1)/Q(-3) = -170
- ROE 5 Year Average 06/2011 = 17.26
- Current Ratio 06/2011 = 1.08
- Current Ratio 5 Year Average = 1.36
- Quick Ratio = 0.98
- Cash Ratio = 0.33
- Interest Coverage =7.9
Company: EMC Corporation (EMC)
Levered free cash flow= $3.06B
- Net Income ($mil) 12/2011 = 2461
- Net Income ($mil) 12/2010 = 1900
- Net Income ($mil) 12/2009 = 1088
- Cash Flow ($/share) 12/2011 = 2.07
- Cash Flow ($/share) 12/2010 = 1.66
- Cash Flow ($/share) 12/2009 = 1.15
- Sales ($mil) 12/2011 = 20007
- Sales ($mil) 12/2010 = 17015
- Sales ($mil) 12/2009 = 14026
- Annual EPS before NRI 12/2009 = 0.62
- Annual EPS before NRI 12/2010 = 1.04
- Annual EPS before NRI 12/2011 = 1.25
- Next 3-5 Year Estimate EPS Growth rate = 16
- EPS Growth Quarterly(1)/Q(-3) = -175
- ROE 5 Year Average 12/2011 = 12.23
- Current Ratio 06/2011 = 1.12
- Current Ratio 5 Year Average = 1.83
- Quick Ratio = 1.02
- Cash Ratio = 0.74
- Interest Coverage Quarterly = 31.19
Company: Canadian Natural Resources Limited (NYSE:CNQ)
- Net Income ($mil) 12/2011 = 2675
- Net Income ($mil) 12/2010 = 1655
- Net Income ($mil) 12/2009 = 1391
- Cash Flow ($/share) 12/2011 = 5.65
- Cash Flow ($/share) 12/2010 = 5.89
- Cash Flow ($/share) 12/2009 = 4.96
- Sales ($mil) 12/2011 = 15483
- Sales ($mil) 12/2010 = 14697
- Sales ($mil) 12/2009 = 9820
- Annual EPS before NRI 12/2009 = 2.68
- Annual EPS before NRI 12/2010 = 2.3
- Annual EPS before NRI 12/2011 = 2.31
- Dividend Yield = 1.4%
- Dividend Yield 5 Year Average = 0.8%
- Dividend 5 year Growth = 21.42%
- Payout Ratio 06/2011 = 0.15
- Payout Ratio 5 Year Average 06/2011 = 0.11
- Next 3-5 Year Estimate EPS Growth rate = 8
- EPS Growth Quarterly(1)/Q(-3) = 1-122.22
- ROE 5 Year Average 06/2011 = 17.14
- Current Ratio 06/2011 = 0.69
- Current Ratio 5 Year Average = 0.75
- Quick Ratio = 0.55
- Cash Ratio = 0.04
- Interest Coverage Quarterly = 16.52
Company: Exelon Corp (NYSE:EXC)
Levered Free Cash Flow = $1.38B
Basic Key ratios
- Relative Strength 52 weeks = 54
- Cash Flow 5 -year Average = 7.72
- Net Income ($mil) 12/2011 = 2495
- Net Income ($mil) 12/2010 = 2563
- Net Income ($mil) 12/2009 = 2707
- Cash Flow ($/share) 12/2011 = 7.64
- Cash Flow ($/share) 12/2010 = 8.42
- Cash Flow ($/share) 12/2009 = 8.07
- Sales ($mil) 12/2011 = 19184
- Sales ($mil) 12/2010 = 18644
- Sales ($mil) 12/2009 = 17318
- Annual EPS before NRI 12/2009 = 4.12
- Annual EPS before NRI 12/2010 = 3.95
- Annual EPS before NRI 12/2011 = 4.16
- Dividend Yield = 4.00
- Dividend Yield 5 Year Average 12/2011 = 4.03
- Dividend 5 year Growth = 23%
- Payout Ratio 06/2011 = 0.51
- Payout Ratio 5 Year Average 12/2011 = 0.49
- Change in Payout Ratio = 0.01
- EPS Growth Quarterly(1)/Q(-3) = 129.92
- ROE 5 Year Average 09/2011 = 23.37
- Return on Investment 06/2011 = 10.4
- Debt/Total Cap 5 Year Average 12/2011 = 49.63
- Current Ratio 06/2011 = 1.1
- Current Ratio 5 Year Average = 1.2
- Quick Ratio = 0.93
- Cash Ratio = 0.4
- Interest Coverage = 159
Long-term investors can use strong pullbacks to slowly start deploying money into long-term investments. One of the best ways to do this is by selling naked puts at strikes you would not mind owning the stock at. In essence, you are getting paid to wait. Investors looking for other ideas might find some in this article - Freeport McMoRan 1 Of 5 Eye Catching Plays.
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.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: Options price table sourced from cboe.com. EPS, Price, EPS surprise charts obtained from zacks.com. A major portion of the historical data used in this article was obtained from zacks.com.