The Covered Call Naked Put Strategy
There are a lot of ways to get into a covered call trade. We actually prefer to use Diagonals but there is another way that can be very profitable if properly traded.
If you trade options for profit or stocks for profit you need to know the best ways to get into potential trades.
You can use Naked Puts to get into a covered call. This gives you the ability to enter a security position at a discount. It also lets you make money if the underlying security stays above your short put and the put expires worthless.
Using a Naked Put to entering to purchase a security actually gives you less risk than simply purchasing the underlying security outright because of the premium you get in selling the naked put.
Let’s look at a couple of examples:
Right now CAT is trading at $127.60. It had a gap down after earnings a couple days ago.
You could sell the FEB19 $120.00 Put for $1.05 or $105.00 per contract. This contract expires in 17 days.
How much you need to sell a Naked Put will very (buying power effect) depending on the price of the underlying. Right now we would need about $3,614.00 in our account to sell this Put so we will start with that as our initial risk.
So, if we sold the FEB19 $120.00 Put and CAT finishes above $120.00 on expiration we just keep the $105.00. Which is a return of 2.9% in 17 days.
Then, we can sell another one or find a better stock to trade.
If CAT finishes below $120.00 then we will have to buy CAT at $120.00 which means we will need to have $12,000.00 in our account for each contract we get assigned.
However, since we were paid $1.05 when we sold the Naked Put we actually are buying CAT at $118.95 per share. As long as it is not below that we still have not lost money.
This is what we mean by getting the stock at a discount. The idea here is to trade stocks you would really like to have at that discounted price.
Since CAT was trading at $127.60 when we made the trade we had $8.65 or 6.8% in downside protection when the trade was initiated.
Let’s look at NKE now.
NKE is trading at $80.34 and trading in a tight channel in what looks like a Bull Flag Pattern. (note: we are actually in swing trade with NKE right now based on that pattern)
We looking sell the FEB19 $79.00 Put for $1.10 or $110.00 per contract.
The initial effect on our buying power to enter this trade is $2950.00
If NKE finishes above $79.00 we just keep our $110.00 or a return of 3.7% in 17 days based on our initial buying power effect.
If NKE finishes below $79.00 then we must have $7900.00 in our account per contract we sold. However since we got $1.10 to sell the put we are actually into NKE at $77.90 which is a discount of $2.47 or 3.1% off what it was trading at when we entered the trade. Again, buying at a discount.
What types of securities should you choose?
- Short answer is ones you don’t mind owning.
- We prefer more established stocks that are not susceptible to wild price swings.
- Stay away from stocks with earnings or news coming out before expiration.
- Keep away from Pharmaceutical companies. They can have announcement out of the blue the will kill these trades.
- You will probably have to sell options 14 to 30 day out at least to get a return to make it worth it.
- Look for obvious support areas on the charts.
- Having a higher Implied Volatility will help you get better prices when you sell your options.
Let us know what you think about this strategy below. We are always interested in your opinions.
Originally Published by Jim Dawson on Trade4Profits.com