by Bryan Perry | June 12, 2014 11:08 am
Markets in the United States and abroad have been bid mostly higher this past week on the confluence of several bullish developments, including proactive fiscal stimulus by the ECB, China initiating targeted stimulus to maintain their annual GDP growth target of 7.5%, Japan’s economy reviving export growth, India’s election of a pro-capitalist prime minister sending that market to new all-time highs, a wave of merger activity and several better-than-forecast data points in the United States, layered with dovish Fed policy.
Those are the macro highlights that had the Dow and S&P punching to new highs. Meanwhile, the Nasdaq and Russell 2000, though not anywhere near record levels, are seeing some capital flows back into biotech, Internet, social-media and cloud-computing stocks, where all the carnage took place earlier this year.
What is taking hold of this rally at the present are hundreds if not thousands of portfolio managers overexposed in long-dated fixed income and sitting on too much cash with the end of the second quarter coming to a close three weeks from now, on June 30. The simple fact is that this rally has put many professionals in a proverbial bind: underinvested in markets, with the train already having left the station. Now it’s like watching a spaghetti western in which the cowboy on horseback has to jump the train at full speed.
The pressure is on big time for portfolio managers and hedge funds to match the market’s performance, as they have less than a month for them to make the proper adjustments to window-dress their portfolios and reflect ownership of the leaders in the markets. With the S&P 500 ahead by 5% year-to-date, that means taking on a higher level of risk if one is lagging the benchmark.
One of the favorite risk-on strategies for professionals is selling naked puts[1], and thanks to progressive brokers, it’s now an easy tactic for the average trader to take, too.
Selling naked puts is a bullish strategy in which you “borrow” put options contracts from your broker, sell them to a buyer, collect the money and then, if all goes well, the naked put goes down in value so that you can buy it back “to cover” for pennies. You get to keep the difference, meaning your profit is the difference from your initial selling price and the price you paid to cover.
Let me give you a naked put trade that you can act on today provided you’ve cleared it with your broker.
“Sell to open” the NOK July $9 puts at $1.10 or more per contract, good till canceled. The option’s ticker is NOK140719P00009000.
Shares of mobile infrastructure maker Nokia (NOK[2]) have been consolidating a big move from last year, when the company sold its handset business to Microsoft (MSFT[3]), and the company now earns its revenue and profits from installing its technology and receiving royalty income from its highly prized patent portfolio. After building an eight-month base, shares of NOK are poised for a new leg higher that is currently in the making.
Nokia has been putting in what is called a “high tight flag” formation that typically ushers in a fresh move to new highs. My target for the stock on this breakout is $9 and then higher thereafter. Assuming this breakout is underway, traders should be able to take home most (if not all) of the July put premium. The sale of 5 puts generates $550 in immediate cash premium.
Assuming you have permission from your broker, by selling a naked put, you’re betting against the buyer of that put option, who thinks that the underlying stock is going down. If the buyer is wrong and the stock goes up, the put will expire worthless — so as the seller, you would have no other obligation other than to pocket your option premium and go home with what amounts to a 100% return.
Before initiating a naked put trade, just make sure you have enough cash on hand to purchase 100 shares of the underlying stock for each one put contract you sell. As, if the stock moves opposite of how you expect and goes down in value – while the put options go up in value – you could get “put” the stock at the option’s strike price, which is $9 in this case. This means you have to buy 100 shares of the stock at $9 for each put contract you sold, or a cash output of $4,500.
But that’s the “worst case” scenario – you own shares of NOK at the strike price. You can then turn around and sell them after they appreciate.
But I think it’s more likely that NOK will move up, and we’ll collect the full premium from selling the puts because despite the underperformance among transports and small-caps this week, the broader market has held up fairly well. The big-cap rotation remains technically healthy, as it affords the market an opportunity to hold its gains and digest some overbought leadership.
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