Naked put

Payoffs and profits from writing a short put

A naked put (also called a uncovered put ) is a put option where the option writer (i.e., the seller) does not have sufficient liquidity (cash) to cover the contracts in case of assignment. No amount of underlying stock will satisfy assignment, because the seller/writer is forced to accept the underlying (from option buyer) in exchange for cash, even if the cash must come by way of a margin call by the seller's broker. If the option buyer doesn't exercise on or before expiration, the seller keeps the option premium. Due to the risks involved, put writing is rarely used alone. Investors typically use puts in combination with other options contracts.^[1]

If the market price of the underlying stock is below the strike price of the option on the day the option expires, the option buyer can exercise the put option and force the seller to buy the underlying stock at the strike price. That allows the exerciser to profit from the difference between the market price of the stock and the option's strike price. But if the market price is at or above the strike price when expiration day arrives, the option expires worthless and the put writer profits by keeping the premium collected when the put option was sold.

During the option's lifetime, if the stock price moves lower, then the option premium may increase (depending on how far the stock falls and how much time passes), and it becomes more costly to close (repurchase the put sold earlier) the position - resulting in a loss. The maximum loss scenario for the put seller occurs if the stock price drops to zero. In that case, the loss is equal to the strike price minus the premium received. Loss is not unlimited, as in the case of a naked call.

References

Mark D. Wolfinger, "The Rookie's Guide to Options" The Beginner's Handbook of Trading Equity Options" W&A Publishing, Cedar Falls, 2008.

↑ Investopedia Staff (17 September 2009). "Introduction to Put Writing". Investopedia. Retrieved 21 February 2012.

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