Short Naked Puts
Another trader, Stacie, has also been studying Johnson & Johnson. Stacie
believes Johnson & Johnson is on its way to test the $65 resistance level yet
again. She believes it may even break through $65 this time, based on
strong fundamentals. Stacie decides to sell naked puts. A naked put is a
short put that is not sold in conjunction with stock or another option.
With the stock around $64, the market for the November 65 put is 1.75
bid at 1.80. Stacie likes the fact that the 65 puts are slightly in-the-money
(ITM) and thus have a higher delta. If her price rise comes sooner than
expected, the high delta may allow her to take a profit early. Stacie sells 10
puts at 1.75.
In the best-case scenario, Stacie retains the entire 1.75. For that to happen,
she will need to hold this position until expiration and the stock will have to
rise to be trading above the 65 strike. Logically, Stacie will want to do an
at-expiration analysis. Exhibit 5.4 shows Stacie’s naked put trade if she
holds it until expiration.
EXHIBIT 5.4 Naked Johnson & Johnson put at expiration.
While harvesting the entire premium as a profit sounds attractive, if
Stacie can take the bulk of her profit early, she’ll be happy to close the
position and eliminate her risk—nobody ever went broke taking a profit.