Naked Puts and Covered Calls
a simple and conservative options strategy.

In option trading there are a vast variety of spread strategies to choose from.
One very basic strategy is to either sell put options by themselves (naked put) OR
sell call options against an existing underlying position (covered call).

These two strategies are profitable if the price of the underlying increases or stays the same.

Selling put options require a large margin up to the value of the underlying for stock options
and much less for futures options.

First let's examine the how a covered call spread is formed: Now, review the PL vs Price chart for a covered call or naked put: As we can see, the profit zone is anywhere at, above, or slightly below the current price.
The profit is small and constant but the risk can be large.

We can vary the strike price of the option to get different profit zones and maximum profits: Naked Put Spread Example

We will use maximum expected return to find the best naked puts.
Maximum expected return = Probability of max reward x max reward

We will use the OEX on 12/14/00 at 710.67 for this example.
We would sort through all available put options to find the option with the best maximum expected return (3rd to last column) below: We will sell 1 Jan-01 820 put for 113 which has the highest max expected return. From the position summary table on the very right, the max expected return for this position is \$1377. This is calculated by multiplying the
maximum reward of \$11,300 by the probability of max reward of 12.18%. The oex must go to 820 for this maximum reward to be attained.
There is a 51.68% probability of profit (breakeven) for the OEX to stay above 707 before expiration about 34 days.
This naked put may require a margin account size up to the value of the contract at \$71,067.

Covered Call spread example

For covered calls, we also will be looking for the option with the highest maximum expected return.
That option turns out to be the 770 call.

So, the covered call strategy is: Buy OEX @ 710.67 and Sell 770 call @ 3.
This strategy produces a maximum expected return of This strategy produces a maximum expected return of \$1596 as seen in the position summary table on the right.
Max Expected return is calculated as: Max reward \$6233 x probability of max reward 25.61%.
This position has a cost of \$70,767. The OEX currently at 710.67 has a 51.38% chance of staying above the breakeven price of 707.67 at expiration
in about 34 days.

Despite requiring a large margin account, naked puts and covered calls when chosen correctly can be a safe and steady
way to profitable options trading.

Copyright 2000 Star Research, Inc.
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