Tastylive: Example of a Short Naked Put

Investors have plenty of ways to use options trades. Most investors use options for a directional bet. Why? If a stock moves higher, a call option can soar. Traders put up far less capital than buying a stock, and see bigger percentage gains.

However, there’s a flip side to options trading. Traders can sell options instead of buy. Doing so can create income. Often, it’s better income than can be earned from simply buying shares of a stock and collecting dividends.

Many investors use covered calls to generate income on top of a stock position. But investors can also sell naked put options. This puts investors on the hook to buy shares of a company if they fall to the strike price of the option.

This strategy can be risky, and may involve holding substantial cash. But it can offer attractive income opportunities.

With a naked put strategy, traders should wait until a stock has fallen and become oversold. A stock that’s fallen heavily should have seen a big jump in put premium.

If the stock rebounds, the put option can decline in value quickly. That allows investors who sold the put to buy back at a lower price, pocketing the difference as profits. If shares languish, it may take more time for the option to play out.

To look at an example of a naked put trade in action, click here.