Selling naked puts is a great way to purchase shares in companies you like at a predetermined price.
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.
- 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.
Suggested Put Strategy for Annaly Capital Management, Inc. (NLY)
Both American Capital Agency Corp (AGNC) and Annaly Capital Management offer lofty yields but in comparison to American Capital Agency, Annaly has been lagging. Not all the secondary offerings of American Capital have been accretive and there are some rumors that these secondary offerings are being used to pay the dividend. Annaly has a much longer dividend history and has one of the best management teams in the industry. As the shares have been lagging there is a good chance that it could break out in the short term. The stock has a decent level of support in the 16.50-17.00 ranges and could test these ranges once again before trending upwards.
The Jan 2013, 16 puts are trading in the $0.46-$0.55 ranges. Sell these puts for 55 cents or better. For this example we will assume that the puts can be sold at $.55 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 a stock you like at a much lower price. Your final price when the premium is factored in will work out to $15.45. If the shares are not assigned to your account, you will walk away with a gain of 3.6% in six months, which works out to a gain or roughly 7.2% per year.
Your potential risk
The risk is limited if you are bullish on the stock and would not mind owning shares at a lower price. Essentially the risk is the same as buying the shares outright but with the added benefit of getting in at a lower price (via the premium you received) or getting paid for your efforts. When you put in a limit order, it is either filled or not. If it's not filled you do not get paid for trying.
Thus only put this strategy to use if you would not mind owning these shares at a lower price. Now if you have a change of heart after selling the puts because you now feel that the stock could trade significantly below the strike price, then you can roll the puts. Buy back the old puts and sell new slightly out of the money puts with more time on them. This procedure usually allows you to walk away with a net credit. Your breakeven point in this trade is $15.45.
A suggestion to boost your potential gains
You could take some of the premium you received from the puts you sold to purchase some out of the money calls. For example, you could purchase the Jan 17.50 calls for 22 cents or better. If the stock takes off, you could walk away with some handsome gains. More importantly, the calls are free as you are using the money obtained from selling the puts to leverage your position. If you are looking for even more leverage you could go after the Jan 19, 2013 calls which are trading in the $0.01 -$0.07 ranges, with the last trade being at $0.05.
Conclusion
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.
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 yahoofinance.com. profit loss chart sourced from poweropt.com.
Disclaimer
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.
