The TRUTH About Selling Naked Put Options

When I just started learning investing, I was constantly warned by my mentor - don't sell naked put options and think that it is easy money!

It was true - back in 2018, he was proved right.

He personally saw people who have been making profits with naked put options for three years straight, lose everything in a week.

That's a true story and I want to do my readers a favor by writing this article.

"Just Sell At A Lower Delta!"

This is what I typically hear - just sell at a lower delta and you will have a lower probability of being exercised.

For those who know about selling put options, have a lower probability of being exercised, meant you are likely to keep the option premium.

This is also the mindset of most novice investors, "I just want to keep the premium, I don't want the stock!"

Remember that selling put options are like selling insurance.

How would you feel if an insurance company told you this, "I just want to keep your insurance premium, who cares about your car."

People tend to forget the idea of selling put options - you are promising to buy 100 shares of the underlying asset at the strike price. They end up having the mindset of only wanting the option premium.

Having a lower probability of exercised meant having a higher win rate.

Here's the thing about a higher win rate that most people don't tell you.

There will always be advertisement out there - "Discover this option strategy with an 83.3% win rate!"

Let me be first to tell you that 83.3% win rate is definitely possible. But they don't tell you the full story. Let me explain.

Let's say we play a dice game. If it rolls anything from 1 to 5, I will pay your $100.

Wow. That's a whopping 83.3% win rate.

But what if I told you...if the dice rolls 6, you will have to pay me $5,000.

Can you see that this game is skewed towards my favor in the long run?

This is exact same game as selling naked put options.

You have a high chance of collecting premium, but it just takes that one moment for you to wipe your portfolio, especially when you are overleveraged.

This is the reason why there were people who were collecting option premium for many years, and it just took one year for them to lose everything.

"Just Keep Rolling The Option!"

If you see your option will be exercised, just keep rolling the option! Eventually, when the stock recovers, you will break even and all is good!

This is another common approach by these people - keeping rolling the option and use the "hope-and-pray" method for the stock to eventually recover.

My question is this - what if it didn't recover fast enough?

This is what happened in 2018 from Sep 2018 to Dec 2018 - which was 3 months.

During that 3 months, the S&P 500 fell by 20%.

These 3 months seemed short, but for those who were selling naked put options, they were panicking. And worse, their broker has already issued them a margin call. They were unable to fulfill the margin call, and they ended up wiping their accounts.

Why is it that they wiped their accounts?

Well, they fall into this idea - "If I sell X naked put options, I can already replace my monthly income!"

They then fall into greed and sell multiple contact of these naked put options at low delta, thinking that it is unlikely for these contracts to get exercised.

When the market kept going down for those three months, most of them have already got a margin call, and their accounts were wiped out.

So if you think you can keep rolling the options and use the "hope-and-pray" method every single time, I urge you to back test and think twice about this strategy.

Why I Wrote This

My biggest fear is when people do not see these risks...especially when they have already been profiting from selling naked put options for several months. And this is a real story from one of my colleagues.

I write this because I genuinely care about people and don't want them to suffer the same margin call as many of those who did back in 2018.

It is extremely painful to see 3 years worth of profits, all gone in a matter of weeks.

The biggest mistake in investing is restarting, and I don't want anyone to have to make this mistake. Can you imagine? If after 3 years, you are back to square one and you basically wasted the past 3 years of your investment journey? Always remember this - time is our most important resource. You will never get those 3 years back.

This is why I believe that self education is ever so important and don't fall into traps of having "high win rates", without understanding the risks involved.