Strategy: Selling Put Options: The Best Income Method?

[botpro]

Not sure what you are referring to when you say 5x margin when the topic is options. When we refer to leverage and equity positions it is simple math based on market value. With options, not so simple. In a PM accounts, the OCC shocks a portfolio based on their VOL skew and the max loss from breaking down the shocks into 5 levels up and 5 levels down, is your requirement. However, Clearing firms use their own calculation based on risk that is more restrictive and rarely used the OCC to calculate that. They use their own shocks and vol curve.

I'm just trying to interpret this passage of the text:

"But, there is another important aspect to selling put options — using margin.

When you sell a put, you’re agreeing to purchase exactly 100 shares of the company if they fall below the strike price. But by using a margin account, which most brokers will allow you to do, you can get by with only depositing one-fifth of the capital — so, enough to buy 20 shares.

Of course, you have to make sure you have enough capital to purchase all 100 shares, but the great thing about put selling is that, if the stock never falls below the strike price, that other 80% never leaves your bank account.

If you use margin on this Intel trade, you can collect a 22% yield right now by entering into a three-month contract. By depositing some capital up front, you’re paid that premium."

IMO, it makes sense, the maths is correct.

 

[rmorse]

I'm just trying to interpret this passage of the text:

I did not read the article. Many of these option mentors and articles offer deceptive information. I'm not saying this person is, since I did not read it. An important metric for an option seller is the return from margin used. Because it is your max profit. That is not the same as the return on equity from your account. You have to account for the fact that no one should use 100% of their buying power for this strategy or you will get frequent margin a calls.

Reg-t margin is similar at many clearing brokers but PM margin varies from firm to firm. And,requirements can change at ANY time, and you must comply.

 

[botpro]

I did not read the article. Many of these option mentors and articles offer deceptive information. I'm not saying this person is, since I did not read it. An important metric for an option seller is the return from margin used. Because it is your max profit. That is not the same as the return on equity from your account. You have to account for the fact that no one should use 100% of their buying power for this strategy or you will get frequent margin a calls.

Reg-t margin is similar at many clearing brokers but PM margin varies from firm to firm. And,requirements can change at ANY time, and you must comply.

The current design of a margin account at the brokers is IMO not optimal.
A better solution would be if each account would consist of 2 parts: a cash part and a margin part.
Then one could specify individually how much goes into the position from the cash part and how much from the margin part.
That way such leverage strategies could be applied much better.

 

[rmorse]

BTW, I quickly skimmed the article. I have expressed my disdain for the statements made in this article in the past. When someone says it's "better" to sell OTM puts on stocks that you want to own anyway because the returns are better, it's just not true. If I love a stock and think it will go up more than the market, I'm missing out by selling OTM puts alone. And, using margin to sell extra puts can be dangerous. I can tell you from experience, that if you are not Buffet, and a stock drops from 100 to 80, and you think you will be happy to buy that stock at 80, you won't be happy. When a stock drops 20%, it just not the same company you liked at 100 or the market is different. It called a losing trade. IMO.

Bob

 

[OptionGuru]

The current design of a margin account at the brokers is IMO not optimal.
A better solution would be if each account would consist of 2 parts: a cash part and a margin part.
Then one could specify individually how much goes into the position from the cash part and how much from the margin part.
That way such leverage strategies could be applied much better.

I think they should just eliminate the Cash Accounts and go with the Margin Accounts only. Why give the choice for a Cash Account?

 

[botpro]

BTW, I quickly skimmed the article. I have expressed my disdain for the statements made in this article in the past. When someone says it's "better" to sell OTM puts on stocks that you want to own anyway because the returns are better, it's just not true. If I love a stock and think it will go up more than the market, I'm missing out by selling OTM puts alone. And, using margin to sell extra puts can be dangerous. I can tell you from experience, that if you are not Buffet, and a stock drops from 100 to 80, and you think you will be happy to buy that stock at 80, you won't be happy. When a stock drops 20%, it just not the same company you liked at 100 or the market is different. It called a losing trade. IMO.

Bob

I understand, but I was thinking of realtime monitoring the position and close it immediately if the credit minus the costs has been eaten up by the drop.
By this the 20% drop of the acct could be prevented IMO, at least under normal circuimstances...

 

[rmorse]

I think they should just eliminate the Cash Accounts and go with the Margin Accounts only. Why give the choice for a Cash Account?

Cash accounts and margin accounts are very different in the way that the clearing firms can use their stocks as collateral. Some fiduciaries and investors don't want their stock lent and don't want margin or loans. Brokerage firms don't like cash accounts but they have to offer them. Being able to lend out your securities is one of the biggest sources of income for a clearing firm.

 

[botpro]

I think they should just eliminate the Cash Accounts and go with the Margin Accounts only. Why give the choice for a Cash Account?

But then a margin acct with 2 parts: a cash and a margin part ;-)

 

[botpro]

Applying the same strategy, but now using a strike that is 10% off of the current spot and using current quotes gives that yield:

INTC
29.59 -0.21 (-0.70%) 4:00PM EST on 2016-02-29-Mo

Calls May 20, 2016
Strike    Price    Change    Bid    Ask    Volume    Open Int
...
26.00    4.00    0.00    3.95    4.10    -    22
27.00    3.50    0.00    3.15    3.25    -    139
28.00    2.48    -0.15    2.40    2.53    5    172
29.00    1.95    +0.25    1.75    1.79    105    8032
30.00    1.33    -0.02    1.20    1.24    38    5529
...

Puts May 20, 2016
Strike    Price    Change    Bid    Ask    Volume    Open Int
...
26.00    0.45    -0.02    0.47    0.51    14    3122
27.00    0.57    -0.08    0.65    0.71    21    2668
28.00    0.95    +0.02    0.92    0.98    1106    7248
29.00    1.26    -0.03    1.28    1.35    17    8029
30.00    1.73    +0.03    1.76    1.82    30    1152
...

cur_spot = 29.59
days     = 81 (= 2.7 months)
strike   = 26 (about 10% lower than the current spot)
mid_put  = (0.47 + 0.51) / 2 = 0.49
credit1  = mid_put = 0.49
profit_potential_normal         = 0.49 / 26 * 100 = 1.88%
profit_potential_with_5x_margin = 5 * 1.88 = 9.4%

Now we have a big cushion of 10% before the stop can hit.

The total credit is of course: 0.49 * 100 = $490 for each contract.

The profit is fix 9.4% in 2.7 months (annualized 49.08%) as long as the stock doesn't fall more than 10%.
(IMHO very unrealistic that INTC falls more than 10%)

Btw, in this analysis the "right entry time" has not been analysed, ie. FA & TA, as well ex-dividend dates etc.
The Call quotes are of course not needed here, it's just for the archive...

Now, this I would classify as a "safe investment".

 

[daniel5198]

The total credit is of course: 0.49 * 100 = $490 for each contract.

???