Naked Put - Explained
What is a Naked Put?
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What is a Naked Put?
A naked put is a strategy peculiar to put options contract, this strategy is one in which an investor writes or sell a put option without holding any short position in the underlying contract. Using a naked put, an investor that holds no position, especially a short position in the underlying security can act as the option writer or seller. A naked put is otherwise referred to as a short put or an uncovered put.
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How Does a Naked Put Work?
In a covered put, an investor trades an underlying security in a put option and also holds a short position to cover the underlying security. This is against a naked put, this is an uncovered put in which an investor sells an underlying security in a put contract without holding any short position, this means that if the option were to be exercised, the investor has no coverage to make a purchase. Many risks are attributed to a anaked put, this type of strategy has a limited profit potential and a significant potential for loss. An investor only makes profit using this strategy if the price for the underlying closes a little above or at the strike price, otherwise, it will amount to a significant loss.
Using Naked Puts
A naked put as an options strategy entails a lot of technicalities, hence, it is only practiced by options investors who have lots of experience. Not just any investor can write or sell put options using the naked put strategy, otherwise, it would amount to a significant loss. Usually, investors that use the naked put strategy do so with the hope that the price of that underlying security rises a little above the strike price or stays at the level of the strike price at expiration. When this happens, earning premium is guaranteed. The premium earned helps investors recover losses on the stock. However, significant losses are associated with naked puts.