(Naked Puts)
by
J.R.
http://www.dancingnakedonwallstreet.com/
Contents:
Preface
Goals
Choosing an Expiration Month
Choosing Stocks
Choosing Strike Price
Naked Put Calculator
Verifying the Spread
Chart Set-up
Other Considerations
Monitor and Manage Trades
Preface
In 1997 I considered myself to be fairly hi-tech savvy. I had a home computer, I was connected to this thing called the internet by a process known as dial-up and I had purchased shares of stock with an online brokerage house. It doesn’t get any more sophisticated than that. I still remember the first four stocks I owned and they were good stocks, I know this because my friends and family told me so, that’s why I bought them.
I would come home after work every day and sit in front of that 12” monitor to check the status of “my stocks”. Some were making a little money. Some were losing a lot of money but I owned them, they were “my stocks”. As time went by watching these four stocks go up then down then back up again it became boring and frustrating to say the least, especially when one of the companies went under and another was bought out. So I stopped watching but I still owned some of “my Stocks” and would tell all my friends and family I bought them online. They were my stocks. Then one day I receive a statement from my online brokerage house with account fees for lack of activity. What? You mean I have to pay extra just to be able to say “I own stock”? Well enough of that game, I liquidated and closed my account.
Ten years later I retired from my day job and decided it was time to learn a lot more about owning stocks. I have spent the last three years learning, reading and applying everything I know about buying and selling stocks.
I have used many different investment techniques, sometimes I am long, sometimes short, most of the time I use some form of option. I have had trades consisting of iron condors, butterfly spreads, calendar spreads, straddles, strangles, you name it been there done that! But what I have found that works for me the best is a simple naked put or one legged vertical spread as I like to refer to it. Using the style I am sharing in this strategy I have year to date (2009) sold 83 naked puts, been put 3 times and increased my account size by 26% just by using this strategy. I felt it worth sharing.
I would like to thank all that have contributed to the development of this strategy, most especially the training staff at Investools, the support staff at Think or Swim, the Shadow Trader and the plethora of authors of the books, manuals, news letters and blogs I have read in the last three years.
Special thanks go out to the weekly trading group that meets at the local library, Leon, Dave W, Dave M, Bob, Jeff and Amy. Every trader new and old should have a resounding board as fun and interesting as you guys.
I am most appreciative to my wife Marilyn, the woman who has stood beside me since before 1975, who has been understanding, supportive and instrumental in all aspects of my life and for not making me get a part-time job as a Wal-Mart greeter.
J.R. 12/10/2009
Goals of Strategy:
Monthly Income.
Possible opportunity to buy good stocks at less than current market price.
DO NOT SELL PUTS ON STOCKS YOU DO NOT WANT TO OWN!!!
Choosing an Expiration Month
Sell puts no further than 39 days out from expiration
Best time frame to sell is during the week of the current month’s expiration through to the end of the following week for the next month’s expiration.
Each expiration to expiration month should give you two/three weeks for selling puts and two/three weeks for monitoring those puts.
Optimum selling weeks for August
Optimum selling weeks for SeptemberExpiration
During the first two weeks of the trade consider placing a limit order at 80% of the original premium. No need to be greedy. If it hits the limit order then consider selling another put at a higher strike for the duration of the expiration cycle.
Continue to run the search daily to look for additional puts to place. Check the charts daily on puts in play and check the news on them.
During the last two weeks of the expiration cycle remove any limit orders. No need to give anything away. Begin looking at puts for the next expiration month.
DO NOT SELL PUTS ON STOCKS YOU DO NOT WANT TO OWN!!!
Choosing Stocks:
Choose fundamentally sound stocks or ETF’s
Choose stocks with as much support as possible between current price and the strike price.
Use a data stream source that provides up to the minute current information.
For the purpose of explanation I have chosen Investools, however there are many brokers and data sources available but it must be able to utilize the search criteria as follows.
Investools Power Proseach Criteria:
This would only return results of stocks or ETF’s that pay out dividends. If you are going to own a great stock why not let them pay you dividends while you do! Of course these criteria will reduce the potential results of the scan as not all stocks or ETF’s pay out dividends to their holders.
All indicators can be adjusted depending on if the search is for stocks or ETFs or for specific market conditions.
The above scan was ran on 12/6/09 and returned the following results:
Choosing a Strike Price
On the trade page find the first strike where the put has 20% or less chance of expiring in the money.
For the purpose of this explanation I have chosen VIV (Vivo Participacoes S.A.) and will use it throughout the rest of this strategy solely for demonstration purposes.
On this page the strike would be $25.00 and the probability of expiring is 10.95%. The theoretical premium price (mid point between the bid and ask price) is $0.23.
Naked Put Calculator:
At this point we take the known information and input it into a simple spread sheet to give us tool to analyze the potential of selling the put.
STOCK SYM = Ticker symbol.
STOCK PRICE = Current price of the stock.OPTION MONTH = Month in which option expires.
STRIKE PRICE = Price chosen which is below 20% P.O.E.
OPTION PREMIUM = Premium paid for choosing a specific strike price.
P.O.E. = Probability of expiring below a specific strike price. No more than 20% (can go to 25% if %B/E is greater than 15%)
NAKED YIELD = (option premium/strike price) minimum no less than 0.6%
%O.T.M. = % out of the money (stock price-strike price)/stock price ) minimum no less than 10%
%B/E = % to breakeven (stock price-(strike price-premium)/stock price) min. no less than 10%
Once the data has been input the information can be sorted by the %B/E column in a descending format to give us the greatest percent of price action loss required to hit the strike price minus what we received for the premium. All of the symbols that do not meet our criteria (shaded in red) can be eliminated from consideration.
Verifying the Spread
Monthly Average True Range
Stock price – Monthly ATR >= Strike price ($25.00)
$32.00 - $4.09 = $27.91
Stock price – Ask price ATM >= Strike price ($25.00)
$32.00 - $4.80 = $27.20
Chart Set-Up
Person Pivots
Set to monthly, show only S1, PP, R1
Looking for a staircase formation where the S1, PP &R1 of the expiration month are all higher than the current month’s respective S1, PP & R1 positions.
Price action should be above the following averages,
30 Day Moving Average
50 Day Moving Average
200 Day Moving Average
MACD
To monitor any convergence and divergence of the set moving average.
News
(Last three posts) Looking for any negative news.
Example of a chart set-up:
If the strike falls below the S1 of the current month and all of the moving averages then the trade is an A+.
If the strike falls below S1 of the current month and two out of three of the moving averages then the trade is a B+.
If the strike falls between S1 of the current month and S1 of the projected month and is below two out of three moving averages then the trade is a C+.
All of the above scenarios are tradable under this strategy.
Other Considerations
Implied Volatility-Chose stocks or ETF’s where the implied volatility for a given stock is 50% to 65% to get the best premiums. Anything over that amount needs to be scrutinized very closely as to why it is so high. (i.e., pending FDA approvals, corporate mergers, C.E.O. scandal and earnings reports).
Earnings Reports – Be VERY CAUTIOUS when earnings report outs are within the time frame of the expiration month. It is best not to trade if earnings are present, but if you do, consider taking profits prior to the report out.
Valuation Analysis – Always nice to see if you are getting a good deal on the price break if put.
Check the last eight Quarterly Earnings
Check the Earnings Estimate page, how many analysts are there? Where do the majority fall on the linear scale?
Monitor and Manage
The Comfort Box
After selling the put, draw a box from the high of the day you initiate the trade to the expiration date then down to the strike price. As long as the price action stays within or above this box you have made an income as you already have the money in your pocket.
If it goes below the box and stays until expiration then congratulations, you are the newest owner of this stock. Goals are met, income made and a good stock purchased at a reduced price.
At this point it would be time to switch strategies to selling covered calls, making an income on stocks you already own while trying to sell them for a profit. Sound a little familiar?
Trading naked puts is like watching paint dry. It is very boring, but very thought provoking!
Posts
