Monday, February 18, 2013

MONEY: Lets get NAKED!

So, for those of you who have no freakin' clue as to what I mean when I say I'm "writing naked puts."  Then I suppose you could go look it up for yourself. If you're lazy then look no further:

If you read that and are confused I don't blame you  It takes a bit of time to wrap your head around the what, how, why, and who.  (Don't ask who... it won't help you)

So I'm going to boil it down for you in as basic terms as is possible!

The simplest way of looking at PUTS is to think of it as an insurance policy...  An insurance policy for your stocks.  There are those who buy the insurance and there are those who are selling it.

The "strike price" is the price at which your PUT gets triggered.  (ASSIGNED)

The "premium" is how much money is required to either buy or sell this "insurance".

The "expiry" is the date at which this contract will cease to exist.

So, say you purchased shares in company "XYZ" (this is not a real company) for $10 a share.  You liked everything about them, but you have doubts about their future performance because of a panoply of reasons.

You can BUY a PUT option to "insure" your holdings.  So if the stock explodes before your "insurance" has expired then you can PUT your shares to the sucker who sold you the contract for the STRIKE price.  (Minus trading commissions and the assignment fee)

If the stock doesn't explode or just goes sideways never falling to the strike price before the expiry date then what happens?  The contract expires and that's it.  You paid for your insurance and didn't need it.  Your premium went to the person who sold you the PUT.

So... if you're the person SELLING the PUT, then you keep the premium and walk away.  So lets review:  The stock goes up - the option expires, the seller walks away with profit.  The stock goes sideways and again, the seller keeps the premium.  If the stock goes down but doesn't hit the strike, then again the seller keeps the premium.  But if the stock tanks, then the seller is responsible for surrendering the agreed price (the strike price) in exchange for the shares.

Now if you look at an "options table" you'll see it's a bit confusing at first, but you will see the list of strike prices and then the "contract price" (both a bid and an ask).  The numbers are somewhat confusing as they are expressed per share rather than per-contract.  So a contract with a value of $1.00 will cost $100 as each contract represents 100 shares.

The values of these contracts ERRODE over time as a large component of their value is determined by the perceived risk of the underlying position AND how long you're exposed to it.  So the greater amount of time before expiry, the larger the perceived risk and thus the greater the premium.

I hope this helps! 

Stay HUNGRY my friends!

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