Naked Puts with SJ Options
In this excerpt from our options mentoring course, Duane gives us some tips on selling Naked Puts. Duane has over 26 years of retail trading experience.
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Good morning guys! In this session, we’re going to talk about naked positions. This is a great topic because it’s one, not only of just understanding the position itself but really understanding and seeing what the risk and exposure is as we use options as our preferred mechanics in handling these trades.
The options are very leveraged and so it needs to be respected. When you go naked with a position, you really do have that maximum exposure. We’re going to talk about that and look at some things and just, I think of nothing else, reacquaint everybody with the exposure that we have in dealing with these. It’s interesting you know. I talk about these things and somebody might say, “Well, why on earth would you ever do anything like that?” And I think that in any situation, whether it’s trading or cooking or firefighting, you name it, whatever the risks and dangers might be, as long as we’re understood, you can work within that.
And that’s definitely the case with what we’re doing here. We just want to make sure we understand exactly what these things mean, exactly what the exposures are, and then work within maybe the trade size, so we don’t feel as exposed, maybe it’s the vehicle itself that we’re working with, so on and so forth. Again, having a solid understanding is the important starting point. It really doesn’t matter what vehicle we talk about. I’ll just go ahead; I’ll just continue to use the Russell like we tend to do a lot. This simple definition first starting in. when you’re naked it means you are short by more contracts than you’re long. In a spread, say a vertical spread, you have the same number of long and short. So, you have one position kind of protecting the other if you will.
You have defined what the limits of exposure are because you have that balanced spread. I think that’s maybe a reasonable starting point where, “Well, gee, if I’m really concerned about having these naked positions, I can do some things in the form of additional positions to help protect that.” But I want to focus just on the naked trade itself. Let’s go ahead and pull up one. Let’s just say on the Russell, we’re looking at the 800 strike and we’re just going to sell some puts. Scale this so it’s a little easier to see.
Now, let’s just talk about what the loss exposure is on this particular trade. It doesn’t matter what vehicle you’re using. If it’s the Index, if it’s Apple, if it’s Google, if it’s Rim, it doesn’t matter. You have the same basic math around it where you’re selling the position at a set strike price and the key risk exposure’s a big price movement against you. You’re going to be forced to spend that much on contracts that now may only be worth 600. And again, the reason for that is that you sold that position and taken on the role, you could think of it this way, the role of an insurance agency to somebody else that 800 strike you’re willing to take regardless of how much the price moves beyond it. In so many words, your maximum exposure would be whatever that strike price is all the way down to zero, when you’re looking at a put. Now the realities are, probably won’t go to zero…