3 Naked Puts On High-ROI Stocks

| February 8, 2017 | 0 Comments

naked putsHere’s a different way to calculate returns on these generous naked puts

This week I’m going to do something a little different as I discuss naked puts. First, let’s remind ourselves what we’re up to with naked puts, which will be an important piece of my forthcoming stock advisory newsletter, The Liberty Portfolio.

With naked puts, you are selling the right for someone to “put,” or sell, the chosen stock to you at a certain price if the stock falls below that price on or before a given date of expiration.

It’s unlikely that the stock will get sold to you prior to that date even if shares fall below the strike price. It is possible, but it only tends to happen if the stock is well below the strike.

Naked puts generate income from the contract, and I only sell them on stocks I want to own, so I don’t mind if they get put to me. I’ll be calculating returns a bit differently this week.

Naked Puts: Dollar Tree (DLTR)

Dollar Tree, Inc. (NASDAQ:DLTR) is a massive dollar retail store, and has performed exceptionally well over the long term. It’s had a recent selloff that I think presents a great opportunity to sell naked puts. DLTR closed Wednesday at $76.39.

By selling the 17 March $75 naked puts, assuming you get $3.10 per contract, you get a “raw real return” of 4.06%, which is calculated by dividing $3.10 by $76.39. Because the contract runs 44 days, that comes out to 33.7% annualized.

Another way to calculate it is to assume DLTR stock is put to you, but that the stock is purchased using margin. Most brokers have a 35% margin requirement for an effective short positions — an amount set aside to partially cover the cost of a potential purchase. So 35% of the total purchase price if DLTR were put to you is $2,625. Thus, what I would call the “gross ROI” would be $310 divided by $2,625, or 11.81%.

Naked Puts: Starbucks (SBUX)

Gross ROI is just another way to compare option trades. Let’s look at another example with it and raw real return for Starbucks Corporation (NASDAQ:SBUX).

SBUX stock has fallen the past few days on earnings results that annoyed some people, but it’s a long-term story and it means being able to get the stock at a cheaper price with naked puts.

SBUX closed Wednesday at $53.90. The 10 March $54 naked puts are selling for about $1.10. So the raw real return here is 2.04%, which comes out to 20.1% on an annualized basis.

Taking our 35% margin requirement on a $5,400 purchase, we come out to $1,890. Dividing $110 into $1,890 gives us a gross ROI of 5.82%.

Naked Puts: Microsoft (MSFT)

Finally, look at Microsoft Corporation (NASDAQ:MSFT), which closed at $63.58 on Wednesday. The 10 March $63.50 naked puts are selling for $1.35. On a raw real return basis that comes out to 2.12%, or 20.9% on an annualized basis. A 35% margin requirement on a $6,350 purchase is $2,222. So our gross ROI is 6.07%.

Now, compare all three. Note that the more volatile stock, DLTR, offers a higher premium but also sells at a higher price. Even though DLTR stock is only $13 more expensive than MSFT stock, or about 20%, and the contract is only one week longer, the premium sells for 130% more, thus creating a higher gross ROI.

SBUX stock is about 20% cheaper than MSFT stock, yet both its raw real return and gross ROI are about the same. The purpose of this exercise is just to show a different way to calculate a return should a stock get put to you, and you elect to actually purchase it instead of just buying back the naked position.

 

Note: This article originally appeared at investorplace.com.  For more trading advice articles, click here…

The author of this article is Lawrence Meyers. Lawrence is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing.

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