Naked put options involve a put option without a short stock position or enough cash to cover it, resulting in greater risk for the investor. Uncovered puts have limited reward potential and high risk, especially for short selling stocks. However, a modest decline in stock price may still result in a net profit due to the premium on the short sale.
Naked put options are situations where the put option does not have a short stock position to accompany the put option. Sometimes referred to as a naked put option, the put option position can also include situations where there is not an equal amount of cash on deposit to cover the put option. Either of these two scenarios results in a greater degree of risk for the investor, including a greater degree of liability in the event that the put option does not perform as expected.
While naked put options with a short put option are a relatively common approach used by a number of investors, there are a couple of points to keep in mind. First, the uncovered put does not have the potential rewards associated with other strategies. In fact, the uncovered option often has very limited reward potential, and this is usually associated with charging premiums.
Second, an uncovered put has a degree of risk built into it that could far outweigh any potential reward. This is especially true of stocks associated with short selling that are going through a downward spiral of value. This may result in the assignment of the put option, leaving the investor with a substantial amount of debt to cover.
However, even if there is a modest decline in the stock price and the naked put option is exercised, that does not automatically mean that the investor will suffer a net loss. In the event that the stock price falls below the exercise price, there is a good chance that the put option will be assigned. This will force the investor to pay for the shares at the higher strike price. While this seems like a loss on the front end, there is a good chance that the amount of the premium on the short sale will make up the difference and still leave a small amount of net profit for the investor.
Smart Asset.
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