The term aggressive put writing conjures up taking on some serious risk. Most traders don't realize it has no more risk than a covered call.

If you own a stock at $40 and write a $45 covered call for $2 your risk is any decline in the stock below $38. The premium received decreases your risk. You want the stock to rise to the call strike and to be called out of your position every month. At least that is what you should want. You should never write covered calls on stocks you want to keep. You should buy stocks specifically for covered calls and exit every month. The longer you stay in a covered call stock the better chance for disaster to happen. It is like winning a bet on red on the roulette table and continuing to bet red on every spin. Eventually black or green will appear and you will give back your winnings.

In writing aggressive puts (naked puts) you don't actually own the stock but use margin to accomplish the same thing. Using the example above if you thought that $40 stock was going to move over $45 you could write a $45 put for about $6 in premium. That is $1 time, $5 intrinsic premium. (Just an example and easier for me to use round numbers.) If the stock moves over $45 at expiration you keep the $6 premium. Your margin risk was 20% of the stock price or $9 making that $6 premium a 66% return. In the covered call example your margin on the stock would be $20 and a move and expire over $45 would net you $7. That is $5 appreciation in the stock and $2 premium. That returns you a 35% gain.

Let's compare the risk. We already discussed the risk on the covered call was anything under $38. The risk on the naked put was anything under $39. The sold strike was $45 and the price at which you would be put if disaster struck. Subtract the received premium of $6 from $45 and you get $39.

All things being relative the $38 and $39 numbers are equal in terms of risk. If disaster struck and the stock gapped down to $20 both positions are going to lose about the same amount of money either $18 or $19. This is not rocket science.

Now, lets compare the same naked put play with one that is supposedly safer. The stock is at $40 and you write a $37.50 put for $1.00. The premium is significantly less because it is out of the money. Where is your risk? It is $37.50 -$1 or $36.50. If the stock drops to $20 you lose $16.50.

Let's compare that with the in the money put strategy. For the ITM put strategy you could lose $19 to make $6. For the OTM strategy you can lose $16.50 to make $1.50. What is wrong with this picture? In the OTM strategy I can make four times the premium but I only have 2.50 more risk.

To me the risk of $16.50, $18 or $19 is basically all the same. Disaster only strikes about once per 100 trades so the $2.50 spread from high to low over 100 trades is negligible. However, in those 100 trades I have the option to make four times the amount of money using the ITM strategy rather than the slightly safer OTM strategy.

If we carry this concept a little farther I think you will grasp it even better. I profiled a trade in the OilSlick newsletter this weekend where we are going to sell a long dated $140 strike on the OIH ETF with the current price at $130. Because we are selling a strike farther into the future than just next month we are getting $30 in premium for selling only $10 in the money. So what is our risk in that trade? It means they market maker cannot put us that stock without losing $20 and should disaster strike and the oil exploration sector implode the ETF has to decline below $110 for us to lose money. Since it is an ETF those types of moves almost never occur.

I have had single stocks decline more than $100 on me in one day back during the Nasdaq bubble. I had written $200 OTM naked puts on Microstrategy (MSTR) and I woke up on a Monday morning to see it trading at $100. I thought it was strange that I did not hear about the 2:1 split. Unfortunately there was no spit and the drop was due to an accounting error and restatement. Fortunately I traded out of that mess and did not lose any money but it was a crazy week until I recovered from that drop. The point here is that any single stock can implode at any time. However, in today's market we rarely see a decline of more than $10 in a single stock other than possibly Google or Apple and we are not going to write puts on them anyway.

Taking this explanation one step further I want you to ask yourself if there is any more risk in writing a $110 put or a $130 put on a $100 stock? Think about it for a minute. One is $10 ITM and the other is $30 ITM.

The answer is the risk is exactly the same. Disregarding any minor time premium there will be a $10 intrinsic premium on the $110 put and a $30 intrinsic on the $130 put. If you subtract those premiums from the strikes you end up with your risk at $100 on both positions. There is absolutely no difference in risk.

Is there a difference in reward in that same scenario? Absolutely yes! Let's say it was a three month put on a strong momentum stock and the stock rallied to $135 over those three months. With the $110 put you make $10 plus a little time premium. With the $130 put you made $30 plus some time premium, which would have been nearly the same in both cases.

So, and I pause here for dramatic effect, your risk was exactly the same but your reward was 300% greater on the $130 put. Which would you choose? I am not even going to glorify the option of writing a $95 put for $3 in the scenario because the risk-reward metrics are so ridiculous compared to the ITM strategy.

Does the stock have to close over $130 to make a profit? Absolutely not. Wipe that concept of "a stock has to close over the strike to be profitable" out of your mind. On either the $110 or the $130 put you are profitable from the first dollar of movement in the stock. If the stock moves to $105 you can cash out for $5, $110 you make $10 but that is where the $110 put ends. Any continued move in the stock price only benefits the $130 put seller.

The option Delta for an ITM put is 100%. For every $1 in stock movement there is a $1 decrease in the premium or increase if the stock moves the wrong way. The Delta is why we want to write ITM puts. An OTM put may have a delta of 50% or less and premium bleeds slowly away. For an ITM put it races away.

Here is my aggressive strategy as clear as I can make it. We want to write ITM puts on stocks, indexes and ETFs that have a strong upward momentum. Typically we want to write 30-60 days out but can go longer. Ideally we want to write puts after market declines or individual stock events but selling in front of stock breakouts is also a good plan. We do NOT want to wait for expiration. We want the play to generate decent profits and then we run for the exits. The longer you are in a play the better chance of a market event that steals back your profit and possibly causes pain.

We want to write puts only on stocks/indexes/ETFs that have time premium built into the option price. Some market makers are smart enough to keep their put premiums just under the spread from stock price to strike price. For instance if the premium on a $120 put for a $100 stock is $18 it is an ambush. If you write that put the market maker will immediately put you the stock and he makes $200 per contract because the premium did not exceed the spread. If the premium was $25 then he cannot put you the stock without losing $500 per contract for the amount of excess premium over the spread. This is a critical point in writing naked puts. Always look for a large time premium.

We also want to look for stocks with a low bid/ask spread on the premiums. Some market makers keep a wide bid/ask spread on the ITM puts in order to discourage trading. Some option chains I looked at this weekend had $2 to $3 spreads between the bid/ask on the option price. For example look at the spreads on the January ITM XLE puts. If you are going to be faced with a $3 penalty when it comes time to sell then you don't want to play in his game.

Lastly we would rather play in a stock that does not have $1 strike prices. Those with $5 strikes have much better premiums. Unfortunately that takes a lot of the ETFs out of play so I will break that rule from time to time.

As in any option writing strategy there is risk of loss. Anything can happen to a stock and knock $20 off it in a heartbeat. Same with writing naked calls. Buyouts happen for significant premiums. You must be prepared to deal with the random unexpected moves in the stock. It does not make any difference if you write $10 OTM or $10 ITM you still have risk.

If you want to see what kind of gains you can get on this type of play the table below is some of the naked puts we played in the OilSlick newsletter this year.

OilSlick Naked Puts

For today the ETFs are tough. The January strikes were just added these weekend and don’t have established bid/ask spreads/prices. That means we have to play in a December or April strike for the common ETFs. I am only going to add a couple plays today and once those strikes populate I will add some more.

If you have any questions about this strategy please use the contact link at the top of the page and I will be happy to answer your questions.

Jim Brown



Aggressive Recommendations


OIH - Oil Service Holders ETF $130.98

The OIH is an ETF containing the major oil service firms like SLB, HAL, NOV, WFT, etc. This sector has almost fully recovered from the recession and from the BP disaster. The OIH is right on the verge of breaking out to a new high. With the dollar dropping, oil prices rising and the economy recovering this group should continue to do well.

I had to choose the April strike on the OIH because the January strikes are non-standard. There was an adjustment for a merger, acquisition or dividend and the strikes are no longer even numbers. Sometimes they are for a non-standard number of shares as well.

We will not hold this put until April. We will only hold it until we have accumulated a decent profit or the sector appears to be in danger of a decline.

Enter this trade only if the S&P and OIH are positive

Premium $15.35 = $9.02 intrinsic, $6.45 time.

Sell Short OIH April $140.00 Put (OIH11P14000) currently $15.35, stop $128.25

Chart of OIH


VMW - WMWare $80.83

VMW has had an amazing recovery since the Wednesday dip to $74. The stock has found new life on the better than expected guidance from Salesforce.com. I do not expect this to slow down. That was a game changer for the cloud sector.

I chose this play because of the decline in October/November and the recent CRM earnings event. There is decent premium in the January strikes. I could see VMW making a new high before Christmas.

Enter this trade only if the S&P and VMW are positive

Premium $11.10 = $9.10 intrinsic, $2.15 time.

Sell Short VMW Jan $90.00 Put (VMW11M9000) currently $11.10, stop $77.75

Chart of VMW


Margin Requirements:

There are several different formulas for determining margin requirements for naked put writing. These are normally broker specific and some can require larger margin requirements than others.

Here is the most common margin calculation for naked puts.

100% of the option premium + ((20% of the Underlying Market Value) - (OTM Value))

For simplicity of calculation simply use 20% of the underlying stock price and you will always be safe. ($25 stock * 20% = $5 margin)