Trade of the Day: Activision Blizzard (ATVI)

Naked puts are one way to make worthless options worthwhile

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Trade of the Day: Activision Blizzard (ATVI)

Calculating Your Costs for Each Naked Put Using Margin

Margin requirements for a naked put I recommend in Cash Machine Trader are generally around $500 to $1,500 per trade, assuming you  trade 1 to 3 contracts. Ergo, out of that $5,000 margin fund, you could easily have two or three naked puts going simultaneously – more if you trade fewer contracts. I typically only have up to three naked puts open at a time, as our main strategy in Cash Machine Trader is short-term covered calls which can be executed in just about any account, even IRAs.

But I like the immediate gratification of naked puts and that they take advantage of the fact that the vast majority of options expire worthless – some estimates say as much as 90%.

Your broker will be able to tell you exactly how much of your margin money will be allocated to a naked put trade. But for a very simple view, the Chicago Board Options Exchange, or CBOE, has a great margin calculator that lets you easily estimate how much margin a typical broker will require for specific trading strategies. Find that margin calculator here and, when you do, select “short put” as your strategy and plug in the details of the ATVI trade.

When doing so, using an illustrative position size of 1 contract, the calculator tells me I could expect a broker to require $556.80 in margin, I would collect $135 from the proceeds of selling one naked put.

3 Possible Outcomes for a Naked Put Trade

The CBOE margin calculator also gives you a “margin call” amount, but that’s not exactly relevant for our purposes, as there are three potential outcomes of naked put trade:

1. The intended outcome, which is that ATVI is trading above the $22 strike price at April expiration and the put we sold to open expires worthless allowing us to keep 100% of the money we collected upfront. Note, it’s not that we doubled our money, but that we collected $1.35 ($135) per put contract that we sold to open and at options expiration, we kept 100% of that.

2. At some point before expiration, ATVI’s chart signals a change in trend and I want to exit the trade early. This can result in a partial profit, or a loss, depending on the situation.

If we sold the naked puts at $1.35, and they have fallen in value to, say, $1.00, we could “buy back to close” the puts and keep $0.35 of the money we originally collected. This means we’d have a net gain in the trade.

But if we sold the naked puts at $1.35, and they have risen in value to, say, $1.50, we would still “buy back to close” the puts but we’d have to pay $1.50 to buy them back. This means we’d have a net loss in the trade.

3. At options expiration, ATVI shares are trading below $22, and the person who bought our naked put contract exercises his or her right to make us buy shares of ATVI at the $22 strike price.

As noted above, owing shares of ATVI is not necessarily a bad thing as the charts are still telling me that ATVI is in a near-term bullish trend. We would just take ownership of the shares at a cost basis of the $22 purchase price, minus any of the money we collected upfront. In this case, we got $1.35, so our cost basis for ATVI shares is $20.65. You simply need to wait until ATVI moves above that $20.65 cost basis and sell your shares at a profit. It’s as easy as that.

So, the “worst case” scenarios for naked puts aren’t so bad, as long as you keep your positions small.  Naked put trades are one of the few options endeavors where “worthless is worthwhile” and I hope I’ve empowered you today to take advantage of their potential.

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Article printed from InvestorPlace Media, http://investorplace.com/2014/03/trade-of-the-day-activision-atvi-naked-put/.

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