Naked Puts (Part 3)
Posted by Mark on November 24, 2015 at 07:00 | Last modified: November 3, 2015 07:03I found some encouraging initial results with regard to the naked put trade but I still need more context to understand what that means and what I can reasonably expect from the strategy.
Prospective investors often want to know if a particular strategy beats its “benchmark.” In order to assess this, I will do an apples-to-apples comparison between naked puts and long shares by equalizing capital risk.
Capital risk for a naked put trade is roughly the strike price minus credit received multiplied by the number of contracts multiplied by 100. For each trade I get a trade gain/loss along with start/ending dates.
For the corresponding shares trade I took the naked put risk divided by underlying price at trade inception to get the number of shares purchased. I then multiplied this by the change in underlying price between the start/ending dates above to get the corresponding trade gain/loss.
As an example, suppose I sell 20 naked puts on XYZ stock, which is currently trading at $100/share. The strike price is $90 and I collect $2.00 per contract. If I get assigned then I have to pay $90/share but I collected $2/share up front. My total risk is therefore:
($90/share – $2/share) * 20 contracts * 100 shares/contract = $176,000.
If you’re into unit analysis, this is:
$/share * contracts * shares/contract = $
“Share” and “contract” mathematically cancel out.
For $176,000, I could buy $176,000 / $100/share = 1,760 shares. The corresponding profit/loss on the shares would then be the price change of XYZ during the trade multiplied by 1,760 shares.
The maximum potential profit on the naked puts would be $2.00/share * 20 contracts * 100 shares/contract = $4,000.
I will show results next time.
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