What is a 'Naked Put'

A naked put is an options strategy in which the investor writes, or sells, put options without holding a short position in the underlying security. A naked put strategy is sometimes referred to as an "uncovered put" or a "short put."

BREAKING DOWN 'Naked Put'

A naked put option strategy stands in contrast to a covered put strategy. In a covered put, the investor keeps a short position in the underlying security for the put option. The underlying security and the puts are sold or shorted in equal quantities. A covered put works in virtually the same way as a covered call. The exception is that the underlying position is a short instead of a long position, and the option sold is a put rather than a call.

A naked put strategy is inherently risky because of the limited upside profit potential and, theoretically, a significant downside loss potential. The risk lays in that the maximum profit is only achievable if the underlying price closes merely at or above the strike price at expiration. Further increases in the cost of the underlying security will not result in any additional profit. The maximum loss is theoretically significant because the price of the underlying security can fall to zero. The higher the strike price, the higher the loss potential.

However, in more practical terms, the seller of the options will likely repurchase them well before the price of the underlying security falls too far below the strike price, based on their risk tolerance and stop-loss settings.

Using Naked Puts

As a result of the risk involved, only experienced options investors should write naked puts. The margin requirements are often quite high for this strategy as well, due to the propensity for substantial losses. Investors who firmly believe the price of the underlying security, usually a stock, will rise or stay the same may write put options to earn the premium. If the stock persists above the strike price between the time of writing the options and their expiration date, then the options writer keeps the entire premium minus commissions.

When the price of the stock falls below the strike price before or by the expiration date, the buyer of the options vehicle can demand the seller take delivery of shares of the underlying stock. The options seller will then have to go to the open market and sell those shares at the market price loss, even though the options writer had to pay the options strike price. For example, imagine the strike price is $60, and the open market price for the stock is $55 at the time the options contract is exercised, the options seller will incur a loss of $5 per share of stock.

The premium collected does somewhat offset the loss on the stock, but the potential for loss can still be substantial. The breakeven point for a naked put option is the strike price minus the premium, giving the options seller a little leeway.

RELATED TERMS
  1. Naked Call

    A naked call is an options strategy in which the investor writes ...
  2. Uncovered Option

    An uncovered option, or naked option, is an options position ...
  3. Naked Position

    A naked position is a securities position, long or short, that ...
  4. Naked Writer

    An options seller who does not own the underlying security for ...
  5. Put Option

    A put options gives the owner the right to sell a specified amount ...
  6. Stock Option

    Stock options give the holder the right to buy or sell shares ...
Related Articles
  1. Trading

    Naked Options Expose You To Risk

    Find out why these enticing options can spell trouble for your bottom line.
  2. Trading

    Naked Call Writing: A High Risk Options Strategy

    Learn how this aggressive trading strategy is used to generate income as part of a diversified portfolio.
  3. Trading

    The Basics of Options Profitability

    Learn the various ways traders make money with options, and how it works.
  4. Trading

    Options Strategies for Your Portfolio to Make Money Regularly

    Discover the option-writing strategies that can deliver consistent income, including the use of put options instead of limit orders, and maximizing premiums.
  5. Trading

    Profiting From Stock Declines: Bear Put Spread Vs. Long Put

    If you're bearish, you should compare the risk/reward characteristics of these two strategies.
  6. Trading

    Options Hazards That Can Bruise Your Portfolio

    Learn the top three risks and how they can affect you on either side of an options trade.
  7. Trading

    When Should I Sell A Put Option Vs A Call Option?

    Beginning traders often ask not when they should buy options, but rather, when they should sell them.
  8. Trading

    How to Sell Put Options to Benefit in Any Market

    The sale of a put allows market players to potentially own the underlying security at a future date, at a price below the current market price.
  9. Trading

    Trading Options on Futures Contracts

    Futures contracts are available for all sorts of financial products, from equity indexes to precious metals. Trading options based on futures means buying call or put options based on the direction ...
  10. Trading

    The Difference Between Options and Futures

    Learn the differences between options and futures, including the risks associated with each.
RELATED FAQS
  1. What is the difference between a covered call and a regular call?

    Learn what a call option is, what two strategies call options can be used for, and the difference between a covered call ... Read Answer >>
  2. How can derivatives be used to earn income?

    Learn how option selling strategies can be used to collect premium amounts as income, and understand how selling covered ... Read Answer >>
  3. Can I make money using put options when prices are going up?

    It seems counterintuitive that you would be able to profit from an increase in the price of an underlying asset by using ... Read Answer >>
Hot Definitions
  1. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  2. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  3. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
  4. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  5. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  6. Cost of Debt

    Cost of debt is the effective rate that a company pays on its current debt as part of its capital structure.
Trading Center