This week’s Striking Price column profiled a do-it-yourselfer who very successfully maintains an account with 10-12 positions of naked puts. Based on what I read it seems like most positions are about 20 lots in size. The way the numbers work out the margin requirements are about $125,000 and the premiums taken in work out to an annual return in the mid 20%’s on the minimum maintenance requirement for the positions.
The article devoted a little space to the what can go wrong part of this strategy but I would have like to have seen a little more. I don’t doubt the success of the investor profiled but the way the article was written it made it seem like he was taking a tremendous amount of risk by way of being over leveraged.
The minimum requirement for a naked put is usually about 20% of the cost to buy the stock. So if I read the article correctly it seems the investor in question is controlling $500,000 worth of stock with $100,000. The downside of this is a drop in the market. If the market goes down by 3% a $500,000 account would go down in value by $15,000. That same $15,000 hit to a leveraged $100,000 portfolio is obviously a 15% hit. This only comes into play, however, if you buy back the puts or get assigned.
Bottom line is be careful with the leverage.