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The buyer of a put stands to profit if the underlying stock drops in price. As might then be expected, the seller of a put will make money if the underlying stock increases in price. It is bullishly oriented strategy.

Since the buyer of a put has a right to sell stock at the striking price, the writer (seller) of a put is obligating himself to buy that stock at the striking price. For assuming this obligation, he receives the put option premium. If the underlying stock advances and the put expire worthless, the put writer will not be assigned and he could make a maximum profit equal to the premium received. He has large downside risk, since the stock could fall substantially, thereby increasing the value of the written put and causing large losses to occur.

Evaluating a Naked Put Write Return
The computation of potential returns from a naked put write is not as straightforward. The reason for this is that the collateral requirement changes as the stock moves up or down, since naked option position is marked to the market. The most conservative approach is to allow enough collateral in the position in case the underlying stock should fall, thus increasing the requirement. In this way, the naked put writer would not be forced to prematurely close a position because he cannot maintain the margin required.

To achieve the maximum potential return, the put would expire worthless with the underlying stock above the striking price. Therefore, the maximum potential profit is equal to the net premium received.

A minimum acceptable level of return must accompany the items on the list of put writes. For example, one might decide that the return would have to be at least 12% on an annualized basis in order for the put write to be on the list of positions.

Writing In-The-Money (ITM) vs. Out-of-The-Money (OTM) Put
ITM Put writing would be a more aggressive strategy. You will be receiving a handsome premium for this risk, but for you to break even the stock has to move forward substantially. Use this strategy very carefully as this is a very risky and aggressive strategy and you are very confident about a bullish move to happen before the expiry.

Most often strategists will be writing OTM puts. This is a less aggressive strategy and similarly will have limited return potential.

Days to Expire
It is important that you write puts keeping in mind the number of days before the put will expire. Too long an expiry time and your risk increases, too short an expiry time and you don’t get the required returns.

We normally pick up Puts with an expiry between 30-45 days. Time decay is rapid in the last month of an option, so to get the best of both worlds in terms of premium and return probability; our experience shows that this time period works the best.

Follow-up Actions
We recommend that you have an exit strategy or a follow-up action decided if the trade happens to go in an unfavorable direction.

For naked put writes we normally would not take any follow-up action but take the assignment and subsequently take ownership of the stock itself. We recommend that you make these trades only on stocks for which you consider that there is a long term price appreciation possible. Once assigned then you can even considering Covered Call strategies to continue with a similar profit graph as the put write.

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