I generally regard options — especially naked puts — as a way to generate modest income on a monthly basis.
However, my strategies are tied into an overall long-term diversified portfolio. Naked puts aren’t just a way to generate additional income — they’re also a way to buy into stocks I’ve been thinking about starting a position in, or adding to.
With naked puts, you are selling the right for someone to “put,” or sell, a stock to you at a given price on or before a given date. If the stock is above that strike price on the expiration date, the stock does not get sold to you, and you keep the premium you were paid for selling that contract.
Some investors, however, have asked about selling naked puts on high-volatility momentum stocks. These carry very high premiums, so it can generate a lot of income for you.
The flip side? You’re also subjected to the risk of having a momentum stock put to you after the momentum has died.
A long way of saying: Just make sure to tread carefully and keep an eye on your trades.
Naked Puts on Netflix, Inc. (NFLX)
Netflix, Inc. (NASDAQ:NFLX) is the ultimate momentum stock. NFLX has surged more than 500% over the past five years — and that includes a nearly 80% dip in mid-2011 that had many thinking Netflix was done for.
Now that we’re 860% higher from its lows … we can put that worry to bed.
Of course, I happen to think NFLX stock is insanely overvalued, but the market clearly has sent it to the moon. So for those seeking high-risk, high-reward naked puts, NFLX stock is for you.
Netflix popped from the mid-$400s to $560 after its last earnings report — and the report wasn’t even that impressive — and it closed Tuesday right below $616 per share.
One strategy would be to sell the Sep $560 naked puts for $24. You collect $2,400 for the contract, and should the stock get put to you, you would get it at an effective price of $536.
Yes, NFLX stock could very well blow up on its next earnings report in late July, so the stock could get put to you on a strong downswing. But if I had to guess, Netflix’s momentum will continue for quite some time as the market fawns over its international expansion and ignores NFLX’s major liabilities.
And even if the stock gets put to you, you’ll probably be able to escape without much of a loss.
Naked Puts on Tesla Motors Inc (TSLA)
Likewise, I think Tesla Motors Inc (NASDAQ:TSLA) does not deserve its $247 price tag.
I remain skeptical about Tesla’s long-term viability, not because of its product — Tesla makes outstanding cars — but because I don’t see a large enough market for them. At least not unless they come at a price point more accessible to a majority of Americans.
But that hasn’t stopped TSLA stock from its wild gyrations and hype that has driven it to sky-high prices.
With TSLA stock trading at $247, you may want to have a look at the Sep $240 naked puts, which are selling for $17. You’ll collect $1,700, and if the stock gets put to you, you’ll get it at an effective price of $1,700.
Of course, there’s a lot less room for error here than with NFLX stock, and I personally don’t like the risk compared to Netflix. But TSLA appears to be Teflon-coated as well, so any short-term decline should be short-lived.
Naked Puts on Chipotle Mexican Grill, Inc. (CMG)
Arguably, the least-risky of my selections for naked puts is Chipotle Mexican Grill, Inc. (NYSE:CMG). In this case, we have a real business generating significant profits and great cash flow. Chipotle carries no debt, and has been expanding at a torrid pace while still managing to stay profitable.
I think CMG stock is a bit overvalued at 30 times next year’s earnings, but it remains a true growth stock with good metrics. The stock closed at $622 on Tuesday, but with $46 per share in cash and short-term investments, the effective stock price is $576. That actually brings it down to 28 times earnings … which, while still high, isn’t unreasonable for a growth stock projecting 20%-plus earnings growth for the next few years.
Thus, selling the Sep $570 naked puts for $13 is not a bad deal. That’s $1,300 in income, and if the stock gets put to you at an effective price of $557, you are not getting a bad deal.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he did not hold a position in any of the aforementioned securities. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
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