Selling Naked Put Options: How to Get Paid to Buy Stocks
by Lee Lowell, Stock and Commodity Analyst
Friday, June 26, 2009: Issue #1027
Right now, bunches of savvy investors are getting paid cold, hard cash for nothing more than agreeing to buy stocks. Investors are giving them money to buy stock that they were looking to purchase anyway.
Sound crazy? Well it isn’t.
There’s an incredibly profitable, but little-known trading and investment strategy that you will come to love as much as I do because of all the “instant cash” it can generate for you.
In the lucrative world of options trading, this strategy is called “selling a naked put option.”
Sounds sexy, and to some it is, but really it’s an incredibly simple way to buy stock you want to purchase at a specific price – while having someone pay you to do it. It’s easy to do but there are a few things you need to know first…
Here’s how you can use this powerful options strategy to get paid for buying stocks.
Understanding Put Option Contracts
If someone has a bearish outlook for a particular stock, they can either sell the stock short or purchase a put option contract. My colleague, Karim Rahemtulla, discussed put options at length in “Short Selling Strategies” last week, but there are some terms to be aware of.
- When you purchase a put option contract, you gain the right to sell that particular stock at a particular price within a specified period of time. To do this, you must pay a fixed amount of money upfront, which is called the “option premium” to the option seller.
- The option seller gets to keep this upfront cash regardless of any future outcome of the transaction.
- The amount at which you can sell the stock is determined ahead of time by the “strike price” – the only price you’ll sell the stock at.
- The time period that the option is active for is also determined ahead of time – and it’s referred to as the “expiration date.”
So as a put option buyer, if the stock you choose ends up falling in price below the strike price you have chosen within the time frame, you will have a winning trade.
It sounds simple enough for most investors to make money hand over fist, but it’s not.
- In about 80% to 90% of option buyer’s transactions, the option will expire worthless and the option buyer ends up forfeiting the option premium he paid upfront to the option seller.
- Most option buyers (both calls and puts) do not end up picking the correct strike price and expiration period to give them a profitable trade.
So who really comes out ahead? The option seller of course – he gets to walk away free and clear with the money. So let’s put ourselves on that side of the trade.
The Secret to Selling Options
Sounds like being an option seller is no-brainer? Well, it is – if you do it correctly.
For getting paid upfront, the option seller also has an obligation to fill if certain conditions arise. His obligation is to buy the stock from the option buyer (remember, the option buyer wants the stock to fall in price) if the stock falls to a certain price within the expiration time period.
Here’s where it gets good.
As a put option seller, you also can determine ahead of time where you would feel comfortable buying a stock if it dropped in price, and then collect the cash from the option buyer.
This is how to be a smart put-option seller – only sell put option contracts at strike prices at which you would like to own the stock if called upon to do so.
That’s it.
The secret to selling naked put options is to pick a stock that you would potentially like to own at a cheaper price than where it currently trades, sell the corresponding strike price, collect the money from the option buyer, and then sit back and wait until option expiration to occur.
Good investing,
Lee Lowell
Related Investment U Articles:
- Options Pricing: Use the Black-Scholes Model to Get a Fair Price for Your Options
- How to Sell Put Options and Snag the Market’s Daily Deals
- Put-Option Selling: Treating the Market Like Your Own Personal Costco
- How to Recover When Your Option Trades Turn Against You
- The Legged Spread Trade: Take 10 Cents and I’ll Show You How to Make It $2.50
12 Responses to “Selling Naked Put Options: How to Get Paid to Buy Stocks”
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Along with Karim, Lee is one of America's leading options professionals. Over the course of a distinguished career, which includes six years in the options "trenches" as a market maker on the floor of the New York Mercantile Exchange (NYMEX), he has developed a proprietary trading method capable of enormous upside while actually reducing risk. 
Excellent article.
Does not indicate how far out to go(expiration date)
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This is also an option question, but not put option. If i sold a covered call and the stock goes over my strike price, is there anything I can do to increase my profit? G. Sayo
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As a matter of fact, there is. It depends on how much the stock price goes up. You can buy back the covered call and sell the stock -IF the stock price has gone up enough that doing so is more profitable than having your stock called away and keeping the call premium. It will generally take a pretty significant move up for it to be worth it, but I have on a number of occasions made more money buy buying back covered calls I had sold and selling the stock upon major bullish moves up.
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Can you explain how much someone needs in their account to do this type of trade? For example, if you don’t own any of the stock that you are selling naked puts on do you need to have the value ot the put stock in your account in case you need to buy the shares at the put price? This is not clear in your explanation. Thanks.
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Selling options in a volatile but sideways trading market is a great concept. But if the market turns anywhere but sideways, you may get hurt, and if a major market move hits, you’ll be slaughtered, especially if it’s sustained.
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That is the great thing about selling puts…you make money if the market goes up, goes sideways or even if it goes down some. I usually sell puts that are about 5 – 10% below the current price of the stock.
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Hi,
you should also discuss the margin requirements, sometime it is huge specially in high price stocks.
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The margin requirements on put selling can be terribly complicated. Various brokerages have various rules.
Leap puts pay the highest fees and put you at less risk if you get 7 for a leap instead of 3 for a 6 month put, but is it more profitable?
If you are promoting puts you must detail margin and cash back up requrements
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I bought Lee Lowell’s book GET RICH WITH OPTIONS about 2 years ago. It sat on my desk for quite some time before I started reading it. After reading it a light went off in my head and I decided that I needed to start selling puts. I started the end of February and my portfolio value is up 70% now only 4 months later.
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“only sell put option contracts at strike prices at which you would like to own the stock if called upon to do so” —that’s great, but if the stock falls below the strike price, then who would “like” to pay more for a stock than it is currently worth?????
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I understand that most people want to sell short term puts but it seems to me that long term put leaps have significant advantages:
1. If over one year they qualify as long term capital gain and have significant tax saving.
2. They have significantly greater time value.
3. An in the money put can always be repurchased as the put approaches expiration.
I understand that a LEAP provides a longer time for the stock to decline but if I sell LEAPs on high quality stocks I think this risk in minimal.
Where am I going wrong?
John
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Great strategy… if you have 25k to open up your trading account.
Is there anything that small time (1-5k) investors can get started with?
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