How to Make Money Going "Naked"
Wednesday, July 30, 2008 | Teeka TiwariRating:
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Today’s article will be short and sweet, and essentially an affirmation of what both Chris Rowe and I are seeing in the U.S. markets.
The beat goes on. After a little scare to the bulls, the market roared back yesterday on the back of weak oil prices ... or so the popular press would have us believe. It’s amazing how each day the financial press seeks out reasons behind market moves. Sometimes they get it right, and other times they like to fit the facts to their opinions.
The fact is we are now in an intermediate bull phase, and dips should be bought into.
If you have not covered your shorts, then do so now before you get squeezed.
Don’t be afraid to look at some groups that have been considered pariahs. The banking as well as the real estate and biotech sectors come to mind.
In fact, after a prolonged period of inactivity in my trading service, Point and Profit, I am about to release a slew of new trade alerts. I’ve been waiting for a pullback that was followed by a strong up day. Yesterday’s action is exactly what I have been waiting for.
There are several ways to play this up move ...
More conservative investors can use ETFs, more aggressive investors can use call options, and middle of the road investors can use the sale of naked puts.
Selling naked puts sounds scary, but if used properly it’s actually a very savvy way to buy stock. This strategy involves selling PUTS against a stock that you do not own but that you want to buy.
Assume that a stock is at $25 and that you want to buy 200 shares. To use this approach you would sell 2 at-the-money PUTS in the front month contract (generally speaking, the earliest available contract with at least 30 days remaining until expiration).
Right now fear is still high, and therefore so are PUT option premiums. I’m seeing $1.5 - $2 premiums in some $25 August puts right now.
Let’s assume that we sell 2 $25 strike price PUT options at $1.50. This means that if the stock goes below $25 by option expiration we will be the proud owners of two hundred shares of stock. The stock will be “put” to us by the brokerage firm. The advantage here is that our cost basis on that $25 stock is only $23.50, thanks to the $1.50 in option premium we took in.
If the stock sling shots away from us and never trades below $25 we still get to keep the $1.50 in option premium!
For many investors that are unsure as to the day-to-day movements of the market, this can prove to be a very beneficial strategy.
Just remember, though, do not sell more contracts than you would normally go long stock. Also be sure to have a stop loss in place on every position you enter. If the stock hits your stop before you have been “put” the stock, simply buy back the puts that you sold and your position will be closed.
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Teeka Tiwari
Chief Investment Officer
ETF Master Trader
