Most brokerage firms will not allow clients to write naked puts as you described.

Could you point the way to one that does?

Thanks.

I have had no problems writing naked puts through Interactive Brokers for a handful of accounts. I am not a pro (far from it) and the requirements to qualify were normal.

As Bill mentioned I think this is a great strategy. I actually use 2 variations on the strategy myself.

On really good companies that seem extremely undervalued I often write longer term puts (12 to 18 months) above the current price but below what seems to be fair value, pocketing the premium (which I can then leverage), having a lower entry point if I'm wrong, or making an nice return if I'm right. For instance, you can take in nice put premiums on a company like Home Depot, which has been heavily out of favor and is at least on a monthly and weekly basis in the accumulation zone (not quite on daily) by writing January 08 puts for $40 or $45 since HD by almost any valuation method should be worth more than that and should eventually get above those levels. On a stock that doesn't pay a big dividends writing puts in this manner has a good chance of netting a higher return then buying the stock. (Although it isn't LT gain treatment).

I also find some shorter term opportunities (3 months or so) when a stock takes a big hit and I can write puts at or below it's current value (like Bill did a month or so ago on Dell) where I either get to take the premium or get the stock really cheaply. I also used this well in the 4th quarter of last year when stocks were down after October and I wrote a ton of puts at or just below the current prices of stocks with a January '06 expiration.

"I received a letter yesterday from an analyst with a Wall Street firm."

Key word; analyst. It's been my experience that most analysts couldn't trade their way out of a paper bag. Although they can be great at predicting future earnings and I use them in that capacity.

Mike,

On your long term put writing strategy, say you wrote a Jan 08 $45 put on HD and pocketed ten dollars and some change at today's quotes. At what price or under what circumstances would HD stock be put to you.

Thanks,

Toby

I use scottrade for online trading. They only allow you to write covered calls. What's a good online firm that allow you to write puts.

Should the naked puts be hedged in some way in case the market caves in?

Toby:

Using your example; lets say I sold $45 puts in HD for $10+. Your question was when would it be put to me.

In my experience so far (2+ years doing this) there are typically only 2 times they get put to me. (1) At or just before expiration if the stock is still below the put price or (2) at times if the stock tanks and the price/date combination of the put becomes extremely unlikely.

Here is a bit mroe detai... Lets say I sell this put. 3 things typically can happen: (1) The stock goes up by that date the puts expire and the $10 is in my pocket. In this case I'm getting cash so there is no" investment" but interactive brokers "puts aside" about 20% of the strike price (for simplicity). So here my "investment" is the idle $9 over 16 months for a $10 return, which is > 80% annualized return. A 2nd possibility is HD could jump well above 45 before then and I could simply close it out for a nice gain early, buying back the option for $1 or less. A 3rd possibility is that HD doesn't move much and isn't near the $45 by sometime toward the middle/end of next year (lets say Sept 2007). In that case I could either assume I'll be put and take the stock cheaper then it is today or I could "roll out" my option, which means (assuming I still like the company) I sell the 2009 puts and use the proceeds to buy back the 2008 puts. (and typically bring in some more premium), which would give the stock more time to get to a fair value. The 4th possibility, which I mentioned above is that HD tanks, lets say drops into the 20's or lower and someone decides to "put" me early. This has happened to me in some situations but not that often.

I'm certainly not an expert but have learned this system from a guy whose been doing it for 20+ years and has done very well. Like Bill, he watches for good companies to get underpriced then writes put options on them (or buys some).

Hope this helps.

Mike

Mike,

Thanks for the information about writing longer term naked puts. One additional question is once you find good companies trading at depressed prices, what steps do you take to determine what the "fair value" of the company should be in order to decide whether it's really at bargain prices.

Thanks again,

Toby

bill --

Recently , Cara 100 components seem ALL to want to support your put-writing strategy.

DELL, DOW, AET, & INTC all spiked down to a "kangaroo tail" and promptly shot up.

Writing a put with a strike just below the "tail" has worked marvelously.

You have trained your "100" very well !

optionsxpress.com allows naked put writing for qualified traders.

Toby:

For established companies with proven track records and earnings it is easier then with young high growth companies. Typically I start by looking at current annual EPS and/or projected earnings multiplied by the low end of a reasonable P/E range. For instance, HD has '07 earnings projection of around $3/share. Historically it has traded above a 20 P/E so to be conservative for the first shot, I'll take 20 x 3 = $60. The question is how reasonale is the historical 20 P/E and/or is something changing. If you look at the ValueLine you can see the P/E for the last 10+ years as well as a median P/E, both of which are higher. Therefore, 20 seems low. 20 is also not out of line for a retailer. At the same time growth at HD is slowing so a more conservative P/E of 18 should give you a real bottom line number on HD. In this case 18 x 3 = $54, which is based on 2007 earnings, and 18 x 3.3 = around $60 based on projected 2008 earnings. Therefore, it is reasonable to think that once the mood shifts on HD and the market strengthens in 2007 or 2008 that $50 to $60 is not an unreasonable fair value for HD. You can go through the same analysis using Price to Book and Price to sales numbers also. Finally, Valueline itself gives you a 2 to 3 year projected price range and many 3rd party sites have valuation estimates - all of which I typically double check when I do a valuation just to make sure my calculations are not way out of sync. Finally, when evaluating stocks like this using Valueline I also like to look in the lower right corner to see the financial strength and earnings predictability of the company.

The fellow that taught me all of this has a blog where he posts audio recordings of weekly phone calls he makes which review stocks he like following this method and writing puts. You can listen to them for free. In this call he describes the stocks he likes and why. Many correspond to Bills list. You can check it out at rightpricepublishing.com if you like. The audio isn't the greatest quality but the content is good. The postings are a few weeks behind but by later today there should be a few new ones.