Selling Naked Puts: Accepting Assignment

One of the more difficult situations for naked put seller occurs when the option is in the money on expiration Friday. I have suggestions for both traders and investors.

Investors

One good strategy for you, an investor who wants to own shares of a specific stock, is to write (sell) one put option for each 100 shares you are willing to buy. By choosing an appropriate strike price, the trader is assured of an acceptable outcome. (Either buy the shares or keep the premium as a consolation prize.) At least buying stock was acceptable at the time the trade was made. If it ever becomes unacceptable (probably because the stock price has declined too far), the investor should repurchase the put option, forget about trying to recover losses, and move on to the next trade.

When the put option is ITM, accept assignment. Translation: do nothing and allow an exercise notice to be assigned to your account. Once you own stock, you may write covered calls or simply hold the stock. This plan works most of the time when you have a long-term outlook.

However, it may be a good plan for a long-term investor, but it is a poor plan for the short-term trader.

Traders

You, the trader, should have a different mindset, and almost never want to own the underlying stock. Do not accept assignment. Cover the short put position, regardless of whether you earned a profit or incurred a loss.

You sold the puts to earn a trading profit. When any trade does not work as anticipated, the winning trader cuts losses and finds another trade.

I know that the advice is often given that it makes sense to accept assignment on short puts and write covered calls until the stock is eventually sold and then begin the process again by writing a naked put. When the plan doesn’t work; when a severe bear market (or some company-specific news) crushes the stock price, the trader loses a lot of money. This is not how a trader operates. The trader is not someone who gets married to a position for the sole purpose of refusing to realize a loss.

A trader is someone with a short-term trading plan. That plan includes a target profit and a maximum acceptable loss. The trader takes that profit when it becomes available. The successful trader understands the importance of limiting losses and accepts such losses when they occur and never holds losing positions hoping they will eventually become profitable.

Remember

When you make a trade remember who you are and make a trade plan that is suitable for your investing style.

New (2014) ebook

New (2014) ebook


Writing Naked Puts

http://goo.gl/eswuZV

One Response to Selling Naked Puts: Accepting Assignment

  1. Kim 02/11/2014 at 1:12 PM #

    Mark Wolfinger,

    Lately i have been thinking about de put-write index strategy (^PUT). The return is different from the buy write strategy (BXM), although this is an equivalent position.
    For example, in 2000 the BXM made 7.4% and the ^PUT 13.1% (almost double). That seems to my as a huge difference for an identical strategy.

    Do you know what the explanation could be?


    The strategies are very similar, but not equivalent.

    The difference is in the strike price of the options being sold. Both PUT and BXM sell options that are out of the money. So regardless of the SPX price, the put-selling strategy always chooses a lower strike price than the call writing strategy.

    Because the market is moving higher, PUT has out-performed. It sells puts with a higher premium and for the most part, the puts have been expiring worthless.

    Another subtle difference is that the put option with the lower strike price has a higher implied volatility (because of skew). Thus, once again, there is an advantage to the methodology of PUT vs. BXM.

    Thanks