I have been selling naked puts for a few months now with the goal of creating immediately investable income. The main risk of selling naked puts is that the stock you took a position won’t go beneath “$X” does go beneath “$X” and you are now holding shares of a company that you might not have otherwise bought. For the first time in the 4 months since making my first trade, I am in the position of having to decide what to do with one a trade that is likely to finish in the money, so why not share my thought process!
What Does it Mean to Sell a Naked Put?
Selling a naked put is an options strategy that states for an upfront premium paid to me today that if the price of a stock goes past the strike point I have to buy it. Let’s look at the example I am currently contemplating:
On 10/24 Under Armour Missed Earnings and had a hard drop
So I sold a put that said in 10 day period it wasn’t going to drop another 5% (approximately $1.50) after the already disastrous 8% drop from $38 to ~$33. Selling that put provided me with current income of $25. Well, I was wrong (or at least I am as of writing this post). The stock is trading under $31 and so I would be forced to buy 100 shares at $31.50 ($3,150) even though the stock is worth less than that – when I took that picture it would be worth $3,074. So let’s discus what I can do in my current situation
Options when Dealing with Naked In the Money Puts
Do Nothing and Let it Play Out
Using the number above (which obviously changes every fraction of a second) I would be signing up for an approximately $75 paper loss. I would be signing up for a $75 or so loss and the stock could fall even more by Friday. Alternatively, the stock could close at $31.51 on Friday and I just walk away with my $25.
Roll the Option to a Future Date
Almost all option strategies are built off of 4 different easy to understand contracts:
- Buying a Call – You have the right to buy a stock at a predetermined price.
- Selling a Call – You have an obligation to deliver the stock at a predetermined price to the option buyer.
- Buying a Put – You have the right to sell a stock at a predetermined price.
- Selling a Put – You have an obligation to buy the stock at a predetermined price if the buyer of the put option wants to sell it to you.
Since I sold a put (remember, the obligation to buy UA at $31.50), to be able to close the contract i would have to Buy a Put to Close. Rolling infers that I would, at the same time, sell another put either at a different expiration date or a different time.
In this example roll, I would be buying to close my put contract and that would cost me $82.50 ($.82 * 100) and then immediately selling another naked put 9 days from now for $122.50 ($1.2250*100). My exact gain would be unknown because it would depend on what occurs at the next strike date, but assuming it was higher than $31.50 then:
- $25 Sale Minus $82.50 Buy to Close = Loss of $56.50
- Sale of $122.50 expiration worthless = Gain of $122.50
- Net Gain $66.
The second example is the same as above except I push the expiration date another week for a 16 days – providing me with an additional few dollars.
What I have Decided to Do with this Particular Stock
With Under Armour I have decided to let the chips lay as they may. The stock is now down 20% month over month and 30% in the past 6 months, my $31.50 will be a multi-year low. Once owned, I will sell covered calls for income until they shares are called away from me for a gain.
What would you do in my position?