How I trade Naked Put.
In TD Ameritrade Thinkorswim Platform, there is a "search" functions where we can list out all the Stocks/ETF (Underlying) that is available in the US Market with the dividend yield, payout ratio and IV percentile. From this list of underlying, I will look at payout ratio, if it is too high, it also likely means that the dividend yield may not be sustainable.
I will then look at the chart; is it on a uptrend or downtrend based purely on Simple Moving Averages, I will also look if there is any reversal candle or trend on the candlestick chart to determine the price level. For simplicity, i will just find a price level below a support price and sell a Naked Put to it.
The option chain that i will look for is around 45 days to 30 days to expiry. This is the best period to sell Option as the time decay factor will start to accelerate from 45 days onwards and it will accelerate even faster when it is < 30 days to expiry.
In my first blog, i have shared the Warren Buffet never buy shares at current price especially when it is overpriced. So we should think like him, at what price are we willing to hold the stock, does it have a support above this price level to decide if you want to sell the option.
So a question you may ask, then why not i sell the option as far away from the current underlying price, so that it will never reach this level and I will collect the premium month after month. The reality is if we sell options further OTM, there is no premium to be collected, no seller/buyer. So we will have to take some low level risk to earn premiums. At a level that you are comfortable with. Some people will trade Options like stocks, they sell/buy at the money or very close to it.
The other condition that we will open the trade is when IV percentile is high as compared to its norm, the option premium will be higher than norm due to price movement (IV percentile at 60% means for the past 52 weeks, 60% of it is below the current IV), when there is price movement of the underlying, usually means we can get out of the market quicker once price movement is back to norm (IV goes back to the means) then our account will start to go +ve.
If we are selling naked put, we do not need to worry about Open Interest. Once you are able to Open the trade (sell the option), your account will be credited with the premium. If the price of the Underlying never reaches the price level, we will keep all the premium and option in your account will be removed by TD Ameritrade Trade desk after the expiry. If you were to take profit at >50 max profit, it means we will have to buy back Options from the market and pay back to the broker some of the Premium which was credited to our account early when we open the trade and some commission and charges.
In Summary:
Selling Naked Puts.
1. Look for a Index or Stock that provides a great Dividend Yield, about 5-6% and has Option Market
2. Dividend Pay Out Ratio is not greater 40% of earnings.
3. Fundamentally sound, good ROE (optional, unless you goes closer ITM for opening the trade)
4. IV Percentile is >50%
5. Open Interest is High (not necessary if it is Naked)
6. Sell Naked Put at the Price level for Options that is expiring in 45 - 30 Days.
7. Decide on a Price Level that you are willing to hold the shares, as far OTM as possible. (should not go closer than 15% ITM)
8. Keep Trades Small. Maintain sufficient cash to perform repair when the need arises.
