It’s that time once again, when companies begin reporting on how things fared in the second quarter.
Earnings season can sometimes create volatility in certain stocks, which is just what those of use who trade naked puts like to see. More volatility means higher premiums, and that means more income from selling our naked puts.
This is a good opportunity to sell naked puts against a particular type of stock — namely, stocks you’ve been thinking about buying into but aren’t quite sure if you should make the plunge.
If you knew that you could get them for a slightly lower price, though, you would be swayed.
That’s what naked puts effectively do. By selling naked puts, you collect a premium. If the stock gets put to you on or before expiration, then you theoretically can apply that premium against the purchase price, resulting in a lower effective entry point.
The thing to always remember when trading naked puts, though, is whether you want those shares or not, there’s a chance they’ll be put to you, so make sure you’ve got the funds to back any trade.
Naked Puts on Whole Foods (WFM)
Whole Foods (WFM) is in perfect position to sell naked puts against.
At Wednesday’s close, WFM stock was at $39.90, so consider selling naked puts at the $40 strike price — it’s close enough to the strike price that you’re simply getting a discount, not a plunging stock, if shares get put to you.
WFM stock reports earnings in late July, and I think buying under $40 is a good deal. However, I also would like a sizable premium, so I would suggest selling the Aug $40 naked puts for $1.75. That’s a very generous 4.4% yield for a 44-day holding period, or 34% annualized.
If WFM stock staggers and falls, you’ll get it a very attractive effective price of $38.25. Even if the stock really gets hit, then I would just average down. If WFM stock flies off the earnings report, you’ve still collected a very solid return by selling this naked put.
Naked Puts on Southwest Airlines (LUV)
Southwest Airlines (LUV) has experienced an unusual selloff recently, down more than 30% from all-time highs set earlier this year and placing it in value territory in regards to other airline stocks.
LUV remains one of the most profitable airlines as far as margins are concerned. For a long time, its balance sheet and cash flow have outclassed every other airline. Customer satisfaction tops the charts.
In other words, I don’t get the selloff, but it does mean you can get into LUV stock for a very attractive price already, and you can tack some income onto the formula by selling naked puts.
LUV stock closed Wednesday at $32.37. You have two choices here because LUV stock reports earnings on July 23. You could sell the weekly July 24 $32 naked puts for 85 cents, which gets you LUV stock put to you for $31.15, and you earn a 2.6% return for a mere 16-day holding period. You also could sell the Aug $32 naked puts for $1.45, and have the stock potentially put to you are $30.55, earning a 4.5% return for a 44-day holding period.
Naked Puts on Netflix (NFLX)
Finally, for all you gamblers out there, Netflix (NFLX) reports on July 15. The stock is at $654.55, and NFLX stock always moves in a very big way after earnings.
I’ve long said NFLX stock is overvalued, but some of you may not agree. I think, if you are gunning for quick and risky income, or think NFLX stock may disappoint and drop, then you sell way-out-of-the-money naked puts.
Consider selling the July $597.50 naked puts for $10.35. If NFLX tanks, you get the stock at $587.15, which is a full $67 below the current price, or about a 10% drop — which given what can happen when a momentum stock trips up, isn’t inconceivable. It could even fall more, though NFLX stock tends to move $50 to $70 after an earnings report. But sometimes it keeps going.
Obviously, this is “only” a 1.6% return for an eight-day holding period, but that does translate to a 73% annualized yield.
You just have to ask yourself which way NFLX stock is going to go.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he was long LUV. 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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