Selling Naked Puts - We Bare All

Reliance Naked Put Option

A Reliance Put Option at a strike price of Rs.1800 with expiry date 31-May-07 means a contract which gives the holder the right, but not the obligation to sell 150 equity shares at a Rs.1800 on or before 31-May-07. The person who sold the option is known as the option writer. A naked put option refers to a put option in which the option writer does not have a short position in the contract or underlying stock i.e. has not sold the contract without owning it.

In other words, if he has shortsold the contract he can square it off by buying back on or before expiry; Since he has not short sold the option contract he will get the premium paid to him in case the buyer chooses not to exercise the option. However, if the market price of Reliance remains below Rs.1800 on the expiry date the option holder may wish to exercise the option by purchasing Reliance shares from the market for, say, Rs.1750 and selling it to the option writer. The buyer gets a profit of Rs.50 per share.

On the last Thursday of April 2007 i.e. 26-Apr-07 the options contracts for the month of April expired and fresh series for the month of May were introduced. The market price of Reliance on 27-Apr-07 was Rs.1539. The Reliance Put Option premium for the 3 strike prices (above market price) traded are given below.

Strike price	Premium
1560	50.15
1590	68.55
1620	88.55

The premium paid is on close basis. The put option contract cannot be exercised without profits unless the market price falls below (strike price – premium) or 1509.85, 1521.45, 1531.45 respectively for the above contracts. Brokerage, commissions and other taxes are not included in this calculation and have to be considered separately for both options transactions and equity share purchases from the market.

During the month of May the market price of Reliance kept going up. The contract strike prices are fixed by the exchange in increments of Rs.30 for Reliance. 1650 strike price contracts began to trade from 03-May-07. As the market price of Reliance was increasing the premium amount of put option kept decreasing, since there was no way of exercising the option.

1800 strike price contracts began to trade from 22-May-07. The premiums for 1800 strike price contracts are given below.

Date	Premium
22-May-07	44.05
23-May-07	58.00
24-May-07	55.00
29-May-07	49.20
30-May-07	50.00
31-May-07	40.00

Let us assume that on 22-May-07 someone bought a put option by paying Rs.44 as premium. On 28-May-07 the market price of Reliance was 1724. So, he could buy from the market at this price and sell to the option writer at Rs.1800. His profits would work out to 1800 - 44 - 1724 = 32 per share or Rs.4800 for 1 lot of 150 shares. (Derivatives like futures and options are always traded in lots.)

The potential risk to the option writer in this case would be, strike price – premium or 1800 – 44 = 1756 for 1 share of Reliance or Rs.263,400 for 1 contract. If he is lucky enough he can sell the Reliance shares at a later date in the market for more than Rs.1800; otherwise he may have to sell for a lower rate and accept the loss.

On the contrary, a ‘covered put’ on Reliance would mean being short on the Reliance stock while selling a put option. The put option, when exercised, will force the option writer to buy Reliance from the option holder. Since the option writer is already short on the market, he can buy the stock from the option holder to square off his short positions, thus reducing his risk.

The Top 5 Bullish Stocks for this Week

In this article let us review some stocks which are technically bullish for the short term. As I have mentioned in my earlier articles these stocks are selected either from A category or B1 category of BSE (Bombay Stock Exchange). This helps in eliminating illiquid stocks, those with listing related issues etc.

Celebrity Fashions Limited:

This is a Chennai based garment exporter company. It has the capability to manufacture the largest number of trousers in the country. The company also has its own national premier menswear brand, Indian Terrain. The clientele include Timberland, Marlboro Classics, Vans, Dockers San Franisco, The North Face, etc. Their design studio at Madras Export Processing Zone (MEPZ) has computer aided design and development for prints and plaids, trend analysis and lifestyle presentation.

It recorded a net profit of Rs.9.41 crores in 2005 – 06; during 2006 – 07 it has reported a net loss of Rs.5.50 crores. EPS too has fallen from 7.19 to -3.09.

The company is being traded since January 2006. The issue price was Rs.180.

On the day of listing, 12 January 2006, it opened at 236.30 and touched a high of 269.90. It kept falling continuously and made a low of 62.10 on 13 June 2007. We have seen in my earlier article, “How do IPO’s perform in Secondary Market?” about how some of the IPO’s have done exceptionally well and some others have failed miserably.

This company has lost nearly 77% from its all time high. The daily chart of the stock is shown below:

The stock has made higher highs and higher lows according to Elliot Wave Theory recently. Though failed in first attempt, it has successfully broken its resistances at 72.70 and 76.75 yesterday. It has even managed to pierce its next resistance at 79.80 though not being able to close above it. Now we may conclude that the stock has bottomed out. This can be confirmed by the money flow index making new highs. 61.8% retracement from the low of 62.10 works out to 96.65.

Gallantt Metal Limited:

The company’s integrated steel plant is located at Kutch, Gujarat. It has the capacity to manufacture nearly 100,000 metric tonnes of sponge iron, 176,420 MT of mild steel billets and 168,300 MT of thermomechanically treated (TMT) bars. It cas a captive power plant too, 18 MW capacity from waste heat and lignite. The company made a loss of 0.976 crores in 2005 – 06 whereas it has made profits of Rs.3.96 crores in 2006 – 07 with a very low EPS of 0.52.

Watch the “cup and handle breakout” in the chart. It is a bullish continuation pattern. We have discussed this pattern in our articles “Buy These India Stocks and Hold for 6 Months” , “These 5 India Stocks Set to Move Up in the Short Term” and also in “5 India Stocks You Need to Own Now”. It can be observed that the pattern has taken about 7 months to complete. The next target for the stock is 17.95.

India Glycols Limited:

This is the only company in the world to produce ethylene oxide / mono ethylene glycol from molasses, a by product of sugar industry. Reliance Industries Limited has MEG plants at Hazira but ethylene is derived from naphtha cracker plant.

India Glycols Limited also produces ethoxylates, performance chemicals, glycol ethers / acetates, guar gum and potable alcohol. It is the largest ethoxylate, glycol ether producer and thus leader in ethylene oxide derivatives / surfactant business in India. It caters to more than 1,000 customers in various end use industries such as textile, agrochemical, oil & gas, personal care, pharmaceuticals, brake fluids, detergent, emulsion polymerisation & paints etc.

It reported a net profit of Rs.41.02 crores in 2006 – 07 at an EPS of 14.72.

The stock had retraced from a low of 99.65 on 28 March 2007 to a high of 153 on 15 May. It has now consolidated for 2 months as can be seen in the chart. On 13 July it had broken out its resistance with volumes. This confirms the bullish breakout. The technical targets for the stock are 202 and 215 once it closes above 172.50 where there is minor resistance (it has been broken on high price basis though.)

Karnataka Bank Limited:

Karnataka Bank Limited is a leading 'A' class scheduled commercial bank in India. It was incorporated on 18 February, 1924 at Mangalore. Over the years the bank grew with the merger of Sringeri Sharada Bank Limited, Chitladurg Bank Limited and Bank of Karnataka.

It has a national presence with a network of 411 branches spread across 19 states and 2 Union Territories. There are about 2.6 million customers for this bank.

Karnataka Bank Limited had declared a net profit of Rs.177.03 crores for the financial year 2006 – 07 at an EPS of 14.6.

Both weekly and daily charts have been shown above. The weekly chart clearly indicates the bullishness for medium term. Watch the bollinger bands contracting towards each other as prices open up. It has broken its resistance in daily chart on 17 July 2007. Short term target works out to 223 and medium term target around 261.

Usha Martin Limited:

This company manufactures steel wires and ropes (at Ranchi), alloys and steels (Jamshedpur), machinery for wire drawing (Bangalore), pre-stressing equipment & accessories (Ranchi) and underground telecommunication cables (subsidiary company Usha Martin Cables near Ranchi). It reported a net profit of Rs.137.45 for the financial year 2006 – 07 at an EPS of 30.32.

Both weekly and daily charts are shown above. We can see the consolidation pattern of about 2 months in daily chart followed by the resistance breakout with volumes. The stock is bullish in weekly as well as monthly charts. The short term target for the stock works out to 340.