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Uncovered Put Write
Writing uncovered puts is an options trading strategy involving the selling of put options without shorting the obligated shares of the underlying stock.
| Uncovered Put Write Construction |
| Sell 1 ATM Put |
Also known as naked put write or cash secured put, this is a bullish options strategy that is executed to earn a consistent profits by ongoing collection of premiums.
Limited profits with no upside risk
Profit for the uncovered put write is limited to the premiums received for the options sold and unlike the covered put write, since the uncovered put writer is not short on the underlying stock, he does not have to bear any loss should the price of the security go up at expiration. The naked put writer sells slightly out-of-the-money puts month after month, collecting premiums as long as the stock price of the underlying remains above the put strike price at expiration.
The formula for calculating maximum profit is given below:
- Max Profit = Premium Received - Commissions Paid
- Max Profit Achieved When Price of Underlying >= Strike Price of Short Put
Unlimited Downside risk with Little downside protection
While the premium collected can cushion a slight drop in stock price, loss resulting from a catastrophic drop in stock price of the underlying can be huge when implementing the uncovered put write strategy.
The formula for calculating loss is given below:
- Maximum Loss = Unlimited
- Loss Occurs When Price of Underlying < Strike Price of Short Put - Premium Received
- Loss = Strike Price of Short Put - Price of Underlying - Premium Received + Commissions Paid
Breakeven Point(s)
The underlier price at which break-even is achieved for the uncovered put write can be calculated using the following formula.
- Breakeven Point = Strike Price of Short Put - Premium Received
Example
Suppose XYZ stock is trading at $45 in June. An options trader writes an uncovered JUL 45 put for $200.
If XYZ stock rallies to $50 on expiration, the JUL 45 put expires worthless and the trader gets to keep the $200 in premim as profit. This is also his maximum profit and is achieved as long as XYZ stock trades above $45 on options expiration date.
If instead XYZ stock drops to $40 on expiration, then the JUL 45 put expires in the money with $500 in intrinsic value. The JUL 45 put needs to be bought back for $500 and subtracting the initial credit of $200 taken, the resulting net loss is $300.
Writing Naked Puts to Purchase Stocks
The biggest risk facing the uncovered put writer is that should the price of the underlying drops below the put strike price, he is forced to buy the shares at the put strike price. However, for a long-term investor looking to go long on the stock at a discount, writing naked puts can be a great way to buy stock. He can do that by writing uncovered puts with a strike price at or near his target entry price. If the stock price drops below the put strike and the puts gets assigned, he gets to make the stock purchase at the desired price.
Additionally, he gets a further discount in the form of the premium earned from selling the puts. Even if the put strike price was not reached and the stock not acquired, he still gets to keep the premiums!
Covered Call Writing
An alternative but similar strategy to writing uncovered puts is to write covered calls. Covered call writing has the same profit potential as the uncovered put write but is executed using call options instead.