Strategy: Selling Put Options: The Best Income Method?

[sle]

Remember Im selling two standard deviations away to begin with so if the stock moves that much on all positions, I'm theoretically flat or have assumed stock at the strike I originally sold.

Would you have enough cash to get assigned on every position you have?

 

[yobo]

Yes as long as I manage my margin correctly. Also keep in mind selling calls against stock can reduce margin calls. If you ever found yourself getting a margin call of say $5000 dollars you have a choice. Sell stock or fund the account. Selling a call is essentially the same as selling stock or funding your account.

I also have other choices when I trade to open a position. I can also just sell cash secured puts without margin. I can put on margin and take off at any time. My approach is not rigid. Many ways to skin a cat. And again if I find myself owning a bunch of stock in the red, there are plenty of strategies such as ratio spreads, selling calls etc to repair.

 

[sle]

Yes as long as I manage my margin correctly.

So lets say you sell puts in 10 names and the market gaps down 5% overnight on the expiration Friday (it has happened multiple times). Let's assume for simplicity that you only have names that have 1-beta with S&P 500 so all your stocks are down 5% too. Do you have enough money to cover the margin calls and, if you get asigned, do you have enough cash to buy all the names?

 

[beefcaketrade]

I almost always sell weekly options. Sell them on Monday or Tuesday and wait till expiration on Friday. I always sell them naked using margin to juice returns. I mitigate the dreaded margin call thru diversifying amongst multiple positions.

To be honest, Ive never experienced a situation where every position goes into the money because I am diversifying amongst 10 positions. However, when a position goes into the money, I have several choices. I can either buy to close the position and take a loss. Assume the position and sell covered calls until I go back to cash, or I can roll the put down and out. I will only take a loss, if the underlying stock has closed the week below the 52 week moving average but even in that case, I may sell a deep in the money covered call and except a smaller profit or a breakeven if I think I can get out and move back to cash the next week.

My general philosophy is to not take losses and continue to sell "time" if the math makes sense and the return is acceptable to me.

But to answer your question another way if every position goes into the money, what would I do and be willing to except for losses all depends...If every position was to go in the money and I found myself looking at losses, I would have to seriously look at the broad market and determine if staying in made sense. Because most likely if all positions collapsed, it would be because of some type of tail risk, I wasnt planning for. In that situation clearly a significant market event has occurred and a shift in trading strategy or just simply complete liquidation would be in order.

I see. If you're selling weekly's then how far out of the money can you actually sell to collect any semblance of premium? Around +/-3-5% tops from where the market is at?

Also, with market volatility in general being fairly low, there is not much risk premium to speak of from which to juice returns. This may force one to increase position size to obtain acceptable real value returns, which also significantly multiplies risk.

Also in a rising and high interest rate environment, the put options pricing factor, rho, takes a negative hit to making put selling less desirable as put prices trend lower with a higher risk free rate. This makes the put selling game less and less ideal in a rising rate environment.

Well the put selling strategy has been described in the past a picking up pennies in front of a steam train. Or as Taleb explains, you win 99% of the time and then that 1% wipes you out. But trading in this fashion is fine too I guess with risk management. That's why credit spreads are better because the loss is capped and the steam roller can't roll you completely flat. If say you risk 30% of total NAV, to make 2% a month, some may argue that is acceptable, as a worst case drawdown is 30%, which is on par with any kind of major portfolio shock, whether or not you were a put seller.

Is put selling so much worse than being bullish and long the market? Probably not. I think there was a study that suggested in 2013 index option put selling was more profitable than being long the market.

But can't it in theory, if you are naked short, just all run a lot against you? Maybe gap moves? In other words you cannot contain the loss? How do you mitigate against that? You can only do that if the price moves were rather gradual. But for single stocks, there can be gap moves.

Personally I would prefer credit spreads. Returns are lower, but so is the risk and so is the margin utilization to hold the position.

 

[yobo]

Good question. So if I had 100k of buying power and I sold puts on stock where if assigned equalled 100k, but because of the gap down my portfolio was now worth 95K, I could either sell CC to make up the 5k or sell stock and realize a 5% loss or actually closer to 10% on my principle and start all over again the following week.

I'm not saying there isnt any risk. And yes a big move in the market could wipe out weeks of gains if all positions went against me. I suppose I could own long dated puts to protect against such things but the cost to insure such a risk makes it very difficult to make any money at all.

I could also define my risk and sell credit spreads but the risk there is that I may have to realize a loss prematurely where I would of been better off being put the stock and just selling calls against it. I don't know of any good way to eliminate black swan events so I trade with an underlying assumption that markets will give me time to adjust. And to manage company and normal market risk thru diversification.

 

[beefcaketrade]

Good question. So if I had 100k of buying power and I sold puts on stock where if assigned equalled 100k, but because of the gap down my portfolio was now worth 95K, I could either sell CC to make up the 5k or sell stock and realize a 5% loss or actually closer to 10% on my principle and start all over again the following week.

I'm not saying there isnt any risk. And yes a big move in the market could wipe out weeks of gains if all positions went against me. I suppose I could own long dated puts to protect against such things but the cost to insure such a risk makes it very difficult to make any money at all.

I could also define my risk and sell credit spreads but the risk there is that I may have to realize a loss prematurely where I would of been better off being put the stock and just selling calls against it. I don't know of any good way to eliminate black swan events so I trade with an underlying assumption that markets will give me time to adjust. And to manage company and normal market risk thru diversification.

Yeah, in theory this practice of put selling, getting assigned and switch to call selling, seems like a good plan. But you can sometimes end up with a huge position you're holding over the long term, especially if you keep trying to average down with more put selling and more assignment. Suddenly your position in this name can get too big. Or you take a loss on the entire position eventually and losing any profit made from premium collected.

And if you don't double down by selling more puts, then your first assignment can be so far OTM, that you can't even sell calls against it.

If you are assigned positions that are too far OTM to derive any covered call premium. What do you do? Do you lower the strike you sell the calls to collect anything (without averaging down) and risk a market rally causing losses in the underlying? Do you average down position to try to get a better price to sell calls? Do you close the position? Do you sit on the position and forget it?

And maybe it was even a gradual decline. So the first time you got assigned, it may be close enough that you can sell some juicy calls. But it falls further. And slowly further. Until at some point you can't sell any calls worth anything and you are stuck. What do you do?

 

[yobo]

I see. If you're selling weekly's then how far out of the money can you actually sell to collect any semblance of premium? Around +/-3-5% tops from where the market is at?

Also, with market volatility in general being fairly low, there is not much risk premium to speak of from which to juice returns. This may force one to increase position size to obtain acceptable real value returns, which also significantly multiples risk.

Also in a rising and high interest rate environment, the put options pricing factor, rho, takes a negative hit to making put selling less desirable as put prices trend lower with a higher risk free rate.

Well the put selling strategy has been described in the past a picking up pennies in front of a steam train. Or as Taleb explains, you win 99% of the time and then that 1% wipes you out. But trading in this fashion is fine too I guess with risk management. If say you risk 30% of total NAV, to make 2% a month, some may argue that is acceptable, as a worst case drawdown is 30%, which is on par with any kind of major portfolio shock, whether or not you were a put seller.

Is put selling so much worse than being bullish and long the market? Probably not. I think there was a study that suggested in 2013 index option put selling was more profitable than being long the market.

But can't it in theory, if you are naked short, just all run a lot against you? Maybe gap moves? In other words you cannot contain the loss? How do you mitigate against that? You can only do that if the price moves were rather gradual. But for single stocks, there can be gap moves.

All good points. If options are priced correctly, they will reflect the implied volatility. One thing I did not mention is that I do not like to trade around events with unknowns such as earnings announcements. I'll typically take a pass on those stocks as one really never knows what will happen. I also do not typically trade options on the market indexes. However I will sell puts on the 3x etfs indexes. Plenty of premium to capture there.

And yes the strikes I sell, are typically 3-5% away from the price of the stock.

Keep in mind I do not approach this strategy blindly. I look at the probabilities of success. I look at the charts and identify support areas, and I look at the company to see if there are any scheduled events that might cause a sea change.

Its not a perfect system, but none are. But it works for me and Ive been doing it for a long time and have survived many volatile days and weeks by developing conviction and a game plan of knowing what to do when trades do not work out the way I want.

Every trader I know has taken their fair share of knocks but eventually finds their path to success. Some traders like to scalp positions, some like to follow a trend, others like to speculate with long calls and puts. Some like to spread trade. It all depends on the individual.

Do you sell options? What is your method?

 

[yobo]

Yeah, in theory this practice of put selling, getting assigned and switch to call selling, seems like a good plan. But you can sometimes end up with a huge position you're holding over the long term, especially if you keep trying to average down with more put selling and more assignment. Suddenly your position in this name can get too big. Or you take a loss on the entire position eventually and losing any profit made from premium collected.

And if you don't double down by selling more puts, then your first assignment can be so far OTM, that you can't even sell calls against it.

If you are assigned positions that are too far OTM to derive any covered call premium. What do you do? Do you lower the strike you sell the calls to collect anything (without averaging down) and risk a market rally causing losses in the underlying? Do you average down position to try to get a better price to sell calls? Do you close the position? Do you sit on the position and forget it?

And maybe it was even a gradual decline. So the first time you got assigned, it may be close enough that you can sell some juicy calls. But it falls further. And slowly further. Until at some point you can't sell any calls worth anything and you are stuck. What do you do?

Well again, I am not trading one concentrated position. With 10 positions, if one goes bad that is only 10% of my capital tied up until I can return the position back to cash. Also remember I have drawn a line in the sand sort of speak by using the 52 week moving average. I'll keep holding a stock as long as it is above. If it closes below on the weekly time frame, I'll get out and lick my wounds.

 

[beefcaketrade]

All good points. If options are priced correctly, they will reflect the implied volatility. One thing I did not mention is that I do not like to trade around events with unknowns such as earnings announcements. I'll typically take a pass on those stocks as one really never knows what will happen. I also do not typically trade options on the market indexes. However I will sell puts on the 3x etfs indexes. Plenty of premium to capture there.

And yes the strikes I sell, are typically 3-5% away from the price of the stock.

Keep in mind I do not approach this strategy blindly. I look at the probabilities of success. I look at the charts and identify support areas, and I look at the company to see if there are any scheduled events that might cause a sea change.

Its not a perfect system, but none are. But it works for me and Ive been doing it for a long time and have survived many volatile days and weeks by developing conviction and a game plan of knowing what to do when trades do not work out the way I want.

Every trader I know has taken their fair share of knocks but eventually finds their path to success. Some traders like to scalp positions, some like to follow a trend, others like to speculate with long calls and puts. Some like to spread trade. It all depends on the individual.

Do you sell options? What is your method?

Leveraged ETFs that track daily performance of the underlying index have a problem and that is decay. So their tendency is to want to go down, even if the trade is working. Which makes it skewed against put selling because it increases your odds of being assigned. They do have juicier premium but commensurate with the risk I suppose.

I do but if I am not holding an underlying position, I try to do credit spreads if I do. Otherwise they are covered positions. I like the idea that losses are capped. There have been a few cases where the underlying blew right past the spread. All I can do is think how lucky vs selling naked and absorbing the entire loss. The spread capped the loss to an acceptable level.

I'm more skewed towards being buyers of premium now to make bullish or bearish bets. Premium selling works, but the short leg can really destroy you if you go wrong, whereas debit buying of premium, you can only lose your premium. The loss is much more defined and much lower than even the confined risk in a debit spread.

 

[beefcaketrade]

Well again, I am not trading one concentrated position. With 10 positions, if one goes bad that is only 10% of my capital tied up until I can return the position back to cash. Also remember I have drawn a line in the sand sort of speak by using the 52 week moving average. I'll keep holding a stock as long as it is above. If it closes below on the weekly time frame, I'll get out and lick my wounds.

10% is your utilization of your buying power?

You can't be 10% NAV risk right because your losses are not capped being naked short? So theoretically you are risking the majority or entirety of the NAV to hold the positions right?