Why do people insist on selling naked puts? You don't want to do anything naked except at home!!! Let's take a moment out to discuss why I think this strategy is the single most braindead strategy known to man, with the possible exception of selling out-of-the-money naked calls.
My job is not to offer investment advice. I am trying to give you insight into the world of trading, courtesy of my almost diary-esque musings about the market.
But I am breaking the rules with this piece. THESE STRATEGIES ARE STUPID and I don't ever want to be associated with them in any way, shape or form. I feel compelled to declare this because so many people on last night's
chat insisted on asking me what I thought of these strategies that I thought I should set the record straight about where I stand.
First, I am not even sure that I would dignify this type of action by calling it a strategy, no more than driving on the wrong side of I-95 is a strategy, or skydiving without a parachute is a strategy. These are all methods of suicide, but only one of them pertains to finance. Here's why.
When you "write" or sell a put you do not own, what you are doing is creating the classic bad "investment." You are cutting off your upside while simultaneously opening yourself to unlimited downside. When you sell a call without owning the stock underneath, you are doing the same thing.
ANY INVESTMENT WHERE I CAN TELL YOU HOW MUCH YOU WILL MAKE UP FRONT BUT NOT HOW MUCH YOU WILL LOSE IS A TERRIBLE INVESTMENT. Period. It is that simple.
How can you lose? Okay, let's say you love love love
. It is your favorite stock. Let's set the clock back to the second week in April. Cendant is trading funky in the mid-30s (no doubt because Sir Walter is getting his buddies out) and you are thinking, boy I love their Net strategy and franchising and all of the other things that attracted me to this situation. But you don't want to pay 35 for it. You want to pay 29 for it. That's where you would like to jump in. So you sell the April 30 put for a buckeroony. Worst that happens, you figure, you "create" the stock at your buy price.
Wrong! You created it at 29 and you got the complete ride down to 16. Your reward could never have been more than a dollar. In other words, had the put gone out worthless the most you could make is a buck. But if it went out in the money, you owned Cendant no matter where. In this case, you risked the shooting match for a $1 reward.
Okay, so you say to yourself, I do that trade every month on, I don't know, pick a stock. How about
National Gift Wrap
? Month after month you sell the 30 puts and they always go out worthless. You believe that you are printing money.
Again, wrong. No amount of months where you "won" can make up for that one time when National Gift Wrap misses its numbers. It simply cannot be justified.
Some people think calls are a much better sale. But how about a takeover? Selling
calls naked (without owning the common) was a super-de-dooper idea until
came along and paid double. Selling
calls made a lot of sense, until
spoiled things. In these situations you are, again, setting yourself up for unlimited risk with a reward that is certain and usually quite tiny. If you don't look at it as a risk/reward, you are wrong.
In 20 years of trading options I can tell you that I have pretty much seen everything that is going to happen and the only time I have ever seen people forced out of this business or had to be liquidated is because they sold puts. The only time. Nothing is worth risking your whole business or portfolio for, least of all selling a put for a buck or two. If you are doing this, please stop.
I have now said my piece on this issue and I am going to ask my editor to archive this prominently so no one will ever have to guess where I stand on the issue of selling naked puts and calls.
What is with these commentators who believe that after a market has jumped 400 points it has no right to go down the next day? After the short-covering final hour Tuesday, it was amazing that the market could get any umph at all, but
sure did help. Let's get something straight. Markets that go up everyday, just like markets that go down everyday, are unhealthy. Profit-taking is the normal course. If no one takes profits -- which is the absence of sellers I was discussing Tuesday -- then your market is not skeptical enough and can be set up for a severe decline. I don't know about the legs of this rally. Many things are obscured by expiration. But to make a judgment that the rally is "over" because on day three the market did not hold in the last hour, well, that seems to be pretty unrigorous thinking...
Can you believe these nutty airlines? This fare increase is now THE battleground out there and I can't see how it can stay in place if one of the participants balks. But then again, if everyone keeps doing everything lockstep, look out for
James J. Cramer is manager of a hedge fund and co-chairman of TheStreet.com.
At time of publication his fund was long Dell and Yahoo, although positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column by sending a letter to TheStreet.com at