Definition
Naked Put
What is the definition of the term "naked put" as it applies to the world of stock trading? What is a "naked put"?
In the world of options trading, a "naked put" is when a person, who has no desire to own shares of the underlying stock, sells a put without having any sort of a hedge in place.
For instance, let's say that you believe that Zillow (Z) has stopped falling. With the stock currently trading at $30, you decide to sell a put at $27.50 that expires in one month. The premium that you collect for the transaction is $1.00 per option, and you end up selling 10 of the options. This means that you are agreeing to buy 1,000 shares of Zillow at $27.50 by the option expiration date. Of course, the person on the other side of the trade will only exercise their option if the price of Zillow is below $27.50 by that date.
Let's say that Zillow misses their earnings and drops to $25 by the option expiration. This means that while you collected $1,000 in premium on the trade, you are now the proud owner of 1,000 shares of Zillow at a price of $27.50. So, you would end up losing $1,500 on the trade.
Now, a "cash secured" put can be a clever way to lower your cost basis in a desired stock, provided that you want to own the stock. A "naked put" is a different story and has been known to cause severe losses for even the savviest of trades. Use at your own risk.
For instance, let's say that you believe that Zillow (Z) has stopped falling. With the stock currently trading at $30, you decide to sell a put at $27.50 that expires in one month. The premium that you collect for the transaction is $1.00 per option, and you end up selling 10 of the options. This means that you are agreeing to buy 1,000 shares of Zillow at $27.50 by the option expiration date. Of course, the person on the other side of the trade will only exercise their option if the price of Zillow is below $27.50 by that date. Let's say that Zillow misses their earnings and drops to $25 by the option expiration. This means that while you collected $1,000 in premium on the trade, you are now the proud owner of 1,000 shares of Zillow at a price of $27.50. So, you would end up losing $1,500 on the trade.
Now, a "cash secured" put can be a clever way to lower your cost basis in a desired stock, provided that you want to own the stock. A "naked put" is a different story and has been known to cause severe losses for even the savviest of trades. Use at your own risk.