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
- It allows one to generate income in a neutral or rising market.
- 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.
- 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.
Some General information to keep in mind
The majority of option players 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.
Suggested Put Strategy for Freeport-McMoRan Copper & Gold Inc. (FCX):
The stock is still in a downtrend and there is chance that it could trade down to the 29.50-30.00 ranges before putting in a tradable bottom. A weekly close above 36.00 on strong volume will turn the outlook on the intermediate time frames to bullish. Our suggestion would be to wait for a test of the 31.50-32.00 ranges before putting this strategy to use. The Jan 2013, 29.50 puts are trading in the 2.22-2.25 ranges. If the stock pulls back to the stated ranges the put should trade in the 3.00-3.30 ranges. For this example, we will assume that the put can be sold for 3.00. Thus for each contract sold $300 will be deposited into your account.
Benefits of this strategy
If the stock trades below the strike price, the shares could be put to your account. In this case, you will have the chance of getting into the stock a stock you like at a much lower price. Your final price when the premium is factored in will work out to 26.50 per share. If the stock is not assigned to your account, you walk away with a gain of 10.16% in roughly seven months.
Your potential Risk
Investors only sell puts when they are bullish on the stock, and so they are ready to purchase the shares at a lower price if they end being assigned to their accounts. The only risk factor is that you have a change of heart after selling the puts. Perhaps you now feel that the stock could trade well below the strike price. In this case, you can roll the put. Purchase the put you sold back and sell new slightly out of the money puts. Your break-even point for this trade is 26.50. Only if the stock trades below 26.50 is when you still start to lose money.
Company: Freeport-McMoRan Copper & Gold Inc.
- Levered free cash flow = $4.00 billion
- Quarterly earnings growth = - 49%
- Quarterly revenue growth = - 19%
- Beta = 2.29
- Operating margins= 40.1%
- Profit margins= 19.3%
- Operating cash flow = 5.06 billion
- Long term debt to equity ratio = 0.35
- Cash Flow 5 -year Average = 5.17
- 5 year sales growth rate = 14.32%
- Operating cash flow = 5.06B
- 5 year capital spending rate = 11.8%
- Net Income ($mil) 12/2011 = 4560
- Net Income ($mil) 12/2010 = 4336
- Net Income ($mil) 12/2009 = 2749
- Net Income Reported Quarterly ($mil) = 764
- EBITDA ($mil) 12/2011 = 10152
- EBITDA ($mil) 12/2010 = 10010
- EBITDA ($mil) 12/2009 = 7416
- Cash Flow ($/share) 12/2011 = 5.95
- Cash Flow ($/share) 12/2010 = 5.77
- Cash Flow ($/share) 12/2009 = 4.4
- Sales ($mil) 12/2011 = 20880
- Sales ($mil) 12/2010 = 18982
- Sales ($mil) 12/2009 = 15040
- Annual EPS before NRI 12/2007 = 4.94
- Annual EPS before NRI 12/2008 = 3.43
- Annual EPS before NRI 12/2009 = 2.96
- Annual EPS before NRI 12/2010 = 4.64
- Annual EPS before NRI 12/2011 = 4.84
- Dividend Yield = 3.6
- Dividend Yield 5 Year Average = 3.10
- Dividend 5 year Growth = 5.07
- Payout Ratio = 0.37
- Payout Ratio 5 Year Average = 0.11
- Next 3-5 Year Estimate EPS Growth rate = 6.9
- ROE 5 Year Average = 32.34
- Return on Investment = 22
- Debt/Total Cap 5 Year Average = 31.21
- Current Ratio = 3.5
- Current Ratio 5 Year Average = 2.33
- Quick Ratio = 2.00
- Cash Ratio = 1.71
- Interest Coverage = 24.2
- Retention rate = 63%
Only implement this strategy if you are bullish on the stock, and you are ready for the possibility that the shares could be put to you. Selling puts is one of the better methods of getting into a stock you are bullish on. You either get in at a lower price, or you get paid for trying to. If you are looking for other investment ideas, you might find this article to be of interest Philip Morris: Extra Earnings Up To 9.6% In 7 Month plus the dividend.
It is imperative that you do your due diligence and then determine if the above strategy meets 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: EPS and Price Vs industry charts obtained from zacks.com. A major portion of the historical/research data used in this article was obtained from zacks.com. Options tables sourced from money.msn.com.