Naked puts are one of my favorite forms of options. Prior to using naked puts, I had always purchased an underlying stock, then sold covered calls against those positions to generate income. The caveat was that these were always stocks that I wanted to own, or at least had no problem owning, in case the price should fall significantly.
Another caveat was that, in my case, I always chose stocks that were undervalued. If the price fell, then I just held an even more undervalued stock.
Then I realized I could accomplish the same thing but without having to tie up my funds in the underlying security. I could sell naked puts against the same stock instead and use the funds for other things. I still collected a premium, and if the stock got put to me, then I’d still be handed an undervalued security I was glad to own.
And that’s the other caveat for naked put sellers: Make sure you have the money to buy the stock if it gets put to you, or be ready to buy back that put at a loss if need be.
Here are a couple of trades I like right now:
Apple (AAPL) Naked Puts
The first slam-dunk trade is with Apple (AAPL). The market completely overreacted to a rather solid earnings report from AAPL and sent the stock down 8%. As I write, AAPL stock is right around $500. The first thing I do is look at AAPL’s net cash position. It’s got $40.7 billion in cash and short-term securities, and another $118.1 billion in long-term investments. Back out the $17 billion in debt, and AAPL net cash is $141.8 billion, or $157 per share in net cash. Wow! So AAPL stock is effectively selling for around $360.
Earnings are slated to grow 8% this year and next, but 19% annually over the next five years, with FY14 EPS projected to be $43.08. I would conservatively give AAPL stock a price-to-earnings ratio of 12, meaning fair value would be about $516. So here it is, trading at an effective price of $348.
If you aren’t comfortable buying the stock outright because of the recent volatility, that’s why you can sell a naked put, and reduce the risk by choosing a strike that’s well out of the money. The July 455 put is selling for $14.67, which is a nice premium. If the stock does get put to you, you get it at an effective price of $455 (strike) – $157 (cash) – $14.67 (premium) = $283.33. That’s at about 6.5 times earnings, and that’s why it’s a slam dunk. (And even not backing out the cash, you’re looking at buying AAPL stock at nearly $440 a share. You don’t think it’ll rebound from there?)
I myself sold the Jan 2015 $470 put before the big crash, for $27. I’m sleeping well at night.
Priceline.com (PCLN) Naked Puts
The other move you can do is to sell a naked Priceline.com (PCLN) put. With the stock at $1,124, and $6.5 billion in net cash, Priceline has $118 in net cash, so the effective stock price is $1,006. Analysts see 20% long-term growth, so with FY14 earnings projected at $51.15, I’d put fair value on a P/E basis at $1,030. So here, I see PCLN stock trading at fair value. If I sell a put below this price, I’d be getting the stock at a bargain level.
The July 900 put is selling for around $19 right now. That’s a fantastic return. I’d be happy to have PCLN stock put to me at an effective price of $881!
As of this writing, Lawrence Meyers holds an AAPL January 2015 470 Put and a PCLN July 940 put. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at firstname.lastname@example.org and follow his tweets @ichabodscranium.