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Eye-Opening Facts About Naked Put Selling
By Ryan Brennan

Do You Sell Naked Puts? If not, you may want to consider doing so. People often stay away from uncovered put writing because they hear that it is "too risky" or that it doesn't have a sufficient risk-reward. The truth is that put-selling, when secured by cash, is actually less risky than owning stock outright and can out-perform the broad market over time. The following article debunks myths surrounding put-writing and explains some of the benefits of this simple-yet-effective strategy.

Put-Selling is Conservative

"The basic concept of option writing is a proven investment technique that is generally considered to be conservative. It can be implemented as 'covered call writing' or, alternatively, 'naked put writing' – which is the equivalent strategy to covered call writing."1

Put-Selling Offers a Better Risk-Adjusted Return 

The Chicago Board Option Exchange (CBOE) has created certain benchmark indices so that investors can compare covered call writing ($BXM), naked put selling ($PUT), and the performance of the S&P 500 Index including dividends ($SPXTR). The chart below compares these indices, with all three aligned on June 1, 1988.

Naked Put Selling Comparison

Although The S&P 500 Total Return Index has slightly outperformed $PUT since inception, one can see the Cboe S&P 500 PutWrite Index ($PUT) has achieved close to the same returns with much less volatility. $PUT averaged 9.65% annually, with a standard deviation of 9.94%, resulting in a Sharpe Ratio of 0.39, while $SPXTR averaged 10.21% annually with a standard deviation of 14.98% resulting in a Sharpe Ratio of 0.29. "For this reason, naked put writing is the preferred option-writing strategy that we employ" in our newsletter services.1

Positions Can Be Hedged

One of the main arguments against put-selling is that the draw-downs can be large in severe market downturns. One way to avoid these draw-downs would be to hedge each individual position or the entire put-sale portfolio. For example, in our publication The Daily Strategist Newsletter, we attempt to offset the market risk that is inherent to option writing by continually hedging our portfolio with dynamic volatility-based modern portfolio protection techniques

The Odds Can Be in Your Favor

Out-of-the-money put-selling win rates based on statistical analysis such as probability and expected return can be quite impressive. For example, The Daily Strategist has produced a combined 89.4% winners in its index and equity naked put-selling/covered-writing trades since the newsletter started recommending them in May of 2007.

In summary, contrary to what may be popular opinion, naked-put writing is a conservative strategy that has the potential to out-perform the broad market over time. When implemented correctly, the strategy can have high rates of success and can also be hedged against large stock market-drawdowns. Investors looking for put-selling trading ideas and recommendations on a daily or weekly basis may be interested in The Daily Strategist or The Option Strategist newsletters. 

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1Lawrence G. McMillan, The Volatility Capture: Total Return Program, 2014, p. 2.

Performance Results: Past performance results for advisory services and educational products are shown for illustration and example only, and are hypothetical.

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM.

ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.