Youe reasoning is wrong because you are confusing different views as being the same thing.
Just theory or workable action plan?
- Thread starter lojze
- Start date
Youe reasoning is wrong because you are confusing different views as being the same thing.
For those who is new to options, you may not realize you need to put up a margin/capital when you write a Put. You are risking significant of capital for small profit which is your premium collected. It is ok when your short position is expired worthless, the tricky part is when the short options are in the money and you been assigned the stock, the next step you then has to consider is what you will do? Become the "buy and hold" and collect dividend? Sell a call against this? How about the stock tanked and the dividend been cut?
This strategy is no different than covered call, only one is bullish and the other one is bearish, with a terrible risk/reward ratio.
This strategy is no different than covered call, only one is bullish and the other one is bearish, with a terrible risk/reward ratio.
Covered call and short put are the same strategy and both are bullish. And the risk/reward isn't necessarily terrible; you just have to have a view that's consistent with the risks of selling a put. Selling a put because you "wouldn't mind" owning the stock is not a consistent view to selling a put.
The margin for selling a put is going to be <= the margin for buying an equivalent notional of stock.
Assume you will use margin as well to buy stock.
What were you assuming?
You're misrepresenting the idea behind this strategy: it's not "Selling a put because you "wouldn't mind" owning the stock" - it's "Selling a put because you "want to" own the stock but prefer to buy the dips; and selling the put pays you while you're waiting - even if the dip never comes."
There's only one scenario where you'd have been better off not using puts to buy the dip: that's if the stock gaps down further than your buy target/put exercise price by an amount greater than your put premium - a very small expected risk when compared to the expected rewards.
The million dollar question is how you will know when a stock will or will not gap down after you write a Put? In teality, Premium generally been priced in those volatile stock, you will not get any good premium if you write a Put on low volatility stock and vice versa.
To me this is still theory and not "practical". No different like saying 'buy low sell high' and etc
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You want the stock to gap down after you write the put as it's your intention to buy the stock on a dip. Some gaps wont bring the price all the way down to the strike price but you hope that it continues down and you get your stock at expiration. Some gaps will go past the strike price but the stock moves back up before expiration; you don't get your stock, but at least you made some money. The only way you can do worse than simply buying on the dip is when the stock gaps down from above to below the strike price minus the premium and stays down until the stock is put to you; had you waited for the dip without using a put, then your limit order would have bought you the stock for less by an amount equal to the strike price minus the premium minus the post gap price. This would be a rare occuance and extremely rare for it to be a large amount; over time, its effect would be trivial in comparison to the option income.
The main trade off is the lost opportunity when the stock dips below the put's strike price but then rises and the put expires worthless; but you get your premium and while you lose the opportunity to own the stock at the dip price, at least you made money without the risk of owning the stock after expiration day. This strategy is not only more profitable than just buying the stock, it's somewhat more conservative too.
This is a fine strategy for a stock that has low volatility; a lower put income is in line with lower profit goals of buying these kind of stocks; and buying volatile stocks by selling puts, while risky, is still overall a bit less risky than buying them directly.
Those all sound good in paper, but let assume the following case in reality;
Current stock price $40
The stock provide a 5% dividend with low volatility and good P/E ratio and etc, e.g. A good candidate to hold in long term
You write a put for $38 strike for €$0.50
The company annouce a bad earning and decide to stop the dividend payment due to "accounting and bad management issue“. The CEO get sacked.
The stock gap down to $36 post earning and move lower "gradually ' (without pullback) to $33 in expiration
Shoud you will follow your strategy, you will be assigned the stock at $38, with the net loss of $4.50 (38-33-0.5).
The stock seems will go down further based on the analysis recommendations with price target of $20
Question : Are you going to hold the Put until expiration post earning or rather taking a loss by buying back the Put before expiration?
No one will write a put for a stock that move lower (similiar as no one will write a Call in SPY in bull market). The problem in put writing strategy is you collect small premium, but when sh** hit the fan, you get caught and force to own a bad stock which WAS supposed a good stock before.
You can argue this is no different as buying a "good" stock that become a "bad" stock, but this is completely different story ( i never buy and hold any "good" stock as i have different investment strategy, I am not Warren Buffet
)