To explain perhaps more clearly, I will use Toronto Dominion Bank which I refer to as TD BANK (symbol on TSX and NY is TD) as an example. Today (March 31 2011) the stock is trading around $86.00. If I sell a put at the $84.00 strike which expires in MAY I am indicating that I am willing to own shares of TD Bank at $84.00 ANYTIME in MAY. Selling this put is a legal obligation to be assigned shares AT ANY TIME up until the third Friday of the month of May. Therefore whether I have the cash readily available or whether I am going to borrow the money (often called margin) to pay for those shares, I am legally bound to own shares at that price. Therefore since I do not yet own the shares I am NAKED. The term "naked" means that I have exposed myself to owning shares that I do not yet actually have in my possession. In other words I am naked the shares as I do not yet own them. The only way out of this legal obligation prior to options expiring in MAY, is to buy back the naked puts which effectively ends the obligation. Of course, if the stock ends up higher than the naked put strike sold, then the seller of the naked put retains all the premium earned.

Selling stock options for income is a favorite strategy and selling puts is my first choice. Naked puts is also often referred to as selling cash secured puts as the investor will often have the cash sitting aside to cover the stock price in the event that the naked puts are assigned. In my mind there is no difference between referring to them as naked puts or cash secured puts. It's all semantics. In this article I will refer to strategy as selling naked puts. Once a put has been sold, the investor is obligated to be assigned shares at the strike price they have sold the put for. Basically they do not own the stock yet, but have indicated their willingness to own the stock at the strike price they have sold the naked put at.