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."
Benefits associated with selling puts
- In essence, you get paid for entering a "limit order" for a stock or stocks you would not mind owning.
- It allows one to generate income in a neutral or rising market.
- 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 you returns over time.
- 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.
- 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.
- Most put options expire worthless and 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. 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 $2.00 and buying it back in the $0.50-$.075 ranges.
Some reasons to be bullish Westport Innovations (WPRT:
- A strong relative strength score of 73 out of a possible 100
- A low long-term debt to equity ratio of 0.16
- A strong quarterly revenue growth of 132%
- The float stands at 42 million shares and the number of shares short is 17 million. Percentage short of float is 40%
- It has a projected 3-5 year EPS growth rate of 30%
- Sales increased from $122 million to $265 million.
- A very good current ratio of 4.63
- An excellent quick and cash ratio of 4.7 and 4.4 respectively
- Year over projected growth rate of 43% for 2013
- $100K invested for five years would have grown to $231K
Suggested Put strategy for Westport Innovations
As this is a volatile stock, it would best to wait for it to trade down to the 22.00-23.00 ranges. A market normally tests its lows before putting in a tradable bottom. Thus, there is a good chance that this stock could also pullback to test its recent lows. This play should only be attempted by those willing to take on some risk as this stock is speculative in nature.
The Jan 2013 20 puts are trading in the 2.35-2.50 ranges. If the stock pulls back to the stated ranges, the option should rise in value from $2.00-2.50. For this example, we will take a midway point and assume that the puts can be sold for $4.60. For each contract sold $460 will be deposited in your account. If the stock trades below the strike price, the shares could be assigned to your account (usually this has to occur on the expiration day). If the stock does not trade below the strike, you get to keep the premium and walk away with a gain of 23% in roughly 7 months.
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
Additional disclosure: EPS and Price Vs industry charts obtained from zacks.com. A major portion of the historical data used in this article was obtained from zacks.com. Options table data sourced from yahoofinance.com. Earnings and growth rate estimates sourced from dailyfinance.com