A Look at Naked Put Options

Although the majority of earnings have already been announced, several companies still need to report. With the recent drop in the market and earnings season upon us, the implied volatility of many options has increased tremendously. When implied volatility is considered high, it can be tempting to sell premium like a naked option. Generally, after the earnings announcement, the implied volatility drops again and so does the option premium. This is naturally a good thing for a seller of an option.

The potential problem is it is also considered to be even more speculative if the position was held over the earnings announcement. A volatility event like an earnings announcement can produce some unpredictable price action for stocks. 

Here is a chart of NVIDIA Corp. (NVDA) taken recently.

At the time of this writing, it was trading at $217.27. The stock just recently pivoted around the $185 level. The company is also expected to announce earnings on Nov. 15. A trader can sell 10 November (expiration after earnings) 185 puts for 4.25 each as seen below.

As long as NVDA stays at or above $185 by expiration, the premium of $4,250 (425 X 10) is the trader’s to keep. But what if the stock gaps widely lower? It was just trading around the $290 level about a month prior and earnings may push the stock even lower. If NVDA announced and the stock traded down to $170 ($15 below the strike, which is possible with a volatile stock) at expiration because of earnings, a loss of $10,750 ((10 X 1500) – 4,250) would be incurred because of the 10 contracts. A seemingly innocent trade has now become a sizable loss.

The fact is we need to be careful when selling premium anytime let alone over a volatile event like earnings. There is a reason the risk/reward is usually slanted toward more risk.

John Kmiecik, Market Taker Mentoring

Trader Education