Thursday, December 2, 2010

Trading Tools - Short Puts

I wanted to take this session of Trading Tools to talk about short puts and how they can be used to generate some extra income.  A lot of traders will do cash secured puts in hopes of receiving the stock they sell puts on but that is never my intent in put selling.

First let me say selling naked options comes at a lot of risk and should be handled carefully. 

Earlier this week NFLX hit the 200 price level so I immediately glanced at its option chain and saw the 180strike selling for .30.

I chose this strike because it had 20 points of cushion before the position would take on a loss.  The key is to get a lot of cushion between the price and the stock.  When a position moves against you it happens fast and at a great loss. 

The put selling I mainly deal with is the weeklys.  You can find out which stocks have weekly options at  I also only look at stocks trading above $100 and this limits me to a few stocks such as NFLX, AMZN, AAPL, BIDU, etc...  I want a stock over $100 because it allows for a bigger cushion space.  Trading weekly options works great as a seller to take advantage of the rapid time decay.  Sell the options Thursday-Friday and you have the whole weekend to eat away at the premium risk free.

One of the first things you will notice about my naked NFLX put is that I only received $30 for it.  This may seem like a small and insignificant amount but the possibility for NFLX to drop 20pts in 3 days was very low.  This allows for an easy, worry free, and "almost" free profit.  (I use almost because there is no such thing as a free lunch). 

One of the first things I do after entering the position is set up alerts on NFLX and the option.  I wanted to know immediately if NFLX ever reach down to $185 and/or the premium doubled.  If either of those had happened I would have instantly exited the trade.

Trading naked options doesn't leave room to guess, wait, or trade without a plan.  NEVER let a stock fall in-the-money and hope it will come back out.  The amount of money you can lose far out weighs the amount of money you will gain.

I look for each position to net around 1-3% gain.  Might seem like a small amount but there is nothing wrong with having consistent worry free gains every week.  Don't go to high on the strikes, or you will get caught in-the-money.  NFLX dropped $7 today which brought it back down to $193.  I am not worried about my 180 strike, as it would have to drop $13 in one day.

It's just good for the extra money...

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