The opposite of covered calls are known as “naked puts,” and these options trades can be a great way to generate additional income or hedge your overall portfolio.
Unlike covered calls, which require you to own the underlying stock and then create a contract to sell the stock to another party, with naked puts you are selling the right for someone else to force you to buy a stock at or below a given price.
Why might you want to do this? If you think a certain stock is more likely to go up, then you are betting it will not go down, and therefore are collecting a premium for making this bet.
For me, I only sell naked puts on stocks that I actually want to own. I just happen to think I can get them a little bit cheaper than the market is pricing them at.
Blue-Chip Naked Puts: Dollar Tree, Inc. (DLTR)
Dollar Tree, Inc. (DLTR) has traditionally been a good choice for naked puts. DLTR stock often has enough volatility to offer some good premiums for selling naked puts, and I would not mind owning the stock.
DLTR has been on a tear. I was initially concerned about digesting the Family Dollar stores that it purchased, because Family Dollar was not a well-run operation. However, investors seems to think that everything will work out fine.
DLTR stock closed on Thursday at $92. You have a couple of choices here. You could sell the July 15 $92.50 naked puts for $2.85. That would give you a 3% return for a 36-day holding period, or 30% annualized. However, you are currently in-the-money.
Or you could sell the July 15 $90 naked puts. In this case, you have a $2 buffer before hitting the strike price, and you collect $1.65 in premiums, which is 1.8%, or 18% annualized.
Blue-Chip Naked Puts: Starbucks Corporation (SBUX)
Starbucks Corporation (SBUX) is a great choice for selling naked puts right now. There’s some skepticism in the market for SBUX stock, which I find mystifying. Clearly, investors are not thinking long-term, and that’s keeping a lid of SBUX stock price.
Yet, Starbucks is a world-class brand with earnings pegged to grow nearly 20% annually over the next five years! What’s more, SBUX generates tons of cash and strong free cash flow, and trades at a reasonable 32 times earnings.
Starbucks stock closed Thursday at $55.57. Meanwhile, you can sell the July 15 $55 naked puts for $1.05, or just about 1.9%. First, that’s 19% annualized. Second, you have nearly a 1% buffer zone (depending on the direction SBUX ultimately takes in today’s trading) before SBUX stock even hits the strike price.
But most of all, I think getting SBUX stock at an equivalent price of $53.95 is a long-term bargain.
Blue-Chip Naked Puts: McDonald’s Corporation (MCD)
McDonald’s Corporation (MCD) is clearly experiencing a successful turnaround. If you’ve been to a store lately, you can see that the company obviously took my advice regarding its menu. It has totally changed things up, offering classics as well as new inventions. The menu is easier to read, and operations appear to be responding favorably.
The stock is up about $30 per share since the turnaround went into effect, and it shows what visionary management can do.
I think MCD is probably a pretty safe bet for a long-term diversified portfolio. Selling naked puts around the closing price of $122.79 is probably not a terrible idea. In this case, I might even think about selling naked puts several months out.
For example, the September $120 naked puts are selling for $3.55. That’s a 3% return over three months, or about 12% annualized. That’s a very safe play likely to pay off over the long term.
As of this writing, Lawrence Meyers was long SBUX.