Puts Part Two
Because the net time premiums of calls and puts with the same stock,strike and expiration can be very close, it often happens that if weare recommending a particular call for covered writing, we are alsorecommending the corresponding put for "naked" put writing as well. OnFebruary 13th, 2002, we were recommending 341 covered calls and "naked"short puts that had the same stock, strike price and expiration.
Leverage and Diversification
Writing uncovered short puts can also allow the investor greaterleverage and diversification. This is because you can write can write agreater number of puts using margin. At present the exchange minimummargin on a "naked" short option is the greater of: (1) 20% of theunderlying minus the amount the stock is out-of-the-money; or, (2) 10%of the underlying. However, along with this leverage comes additionalrisk since one can lose many times the original margin if there is abig enough decline in the stock.
One way to help modify this risk is to buy index options to hedge a portfolio of "naked" put writes.
In Table 2, we have selected six recommended put writes for a totalmargin cost of $12,583 versus about $60,000 that it would take toestablish the same positions as covered calls. In our example, we havebeen able to cover some of the risk of these positions by buying indexoptions that will produce a partial offset if the market declines.
Note: another way to cover the risk of a short put is to buy a lowerstrike put as well. This creates a spread known as a bull put spread.(See "Credit Spreads as Naked Write Alternatives,' also in thisseries.)"
About Lawrence D. Cavanagh
Lawrence D. Cavanagh is Editor (and Senior Analyst) of The Value Line Daily Options Survey. The Value Line Daily Options Survey offers evaluations and rankings on virtually the entire universe of regularly listed equity and ETF options, using the Value Line common stock ranks and proprietary volatility forecasting methodology. Before joining Value Line in 1991, Mr. Cavanagh was an options strategist for Capital Market Technologies (subsidiary of Elders Finance), helping design long-term synthetic foreign currency and gold option hedges. Before that, he was Director of Foreign Currency Options for the Chicago Board Options Exchange. Other work experience includes Dean Witter Reynolds (VP, Senior Currency Analyst), European American Bank (Director of Currency Forecasting) and the Federal Reserve Bank of New York (Assistant Economist).
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