I've heard that about 70% of all puts and calls expire worthless.
I'm considering an approach of selling out-of-the-money puts, and to protect
against the underlying stock having a massive decline, taking the loss if
the put doubles in value; i.e. if I sell it for $ 1, I'll buy it back if it
goes to $ 2, but if it stays above $ 2, I'll wait until the expiration date,
hoping it expires worthless.
If more than half expire worthless, I should come out ahead. If not, it
means that the bear market is back and I need to lay low or start selling
puts on options on ETFs that short the stock/
Has anyone got any advice on this approach? One year I made $ 60,000
selling puts, then lost it all when the market turned down. I think I
should have followed my above-stated exit strategy. Hopefully I learned to
cut those losses.
Not necessarily. Even if almost all of them expire worthless, all it
takes is one to move massively against you and you'll lose money on
the whole shooting match.
If you graph out virtually any option strategy you'll see there's a
(not quite literal) "conservation of risk". The wider the price band
of the underlying in which the strategy is profitable, the less the
profit is and the more disastrous the non-profitable zones will be.
[Reminds me a bit of fourier transforms from my EE days -- the more
spread out a signal is in one domain, the more of a single spike it is
when transformed to the other domain.]
Rich Carreiro email@example.com
now includes an exit strategy. If there is a massive move but you take the
loss before you lose more than your potential profit that would prevent huge
losses--UNLESS there was vary large sudden move like if you sold a put for $
1 and the stock dropped suddenly from $ 100 to $ 70 before you knew what hit
you. That shouldn't happen if you stick to ETFs like SPY. Of course there
are times when even with the best plan, the market could consistently move
against you and the best plan would then be to stand aside.
I'll be testing it out on a small scale.
That depends on the frequency of large stock market drops and the
level of option premia. Emprically, option selling strategies on the
S&P 500 have been profitable -- one can look at the BXM and PUT
indices of the CBOE http://www.cboe.com/micro/BuyWrite/introduction.aspx
Cash covered puts is equivalent to covered calls. My brokerage account
doesn't allow me to sell puts (ignorance on their part), but I can
sell covered calls.
Selling puts lets you avoid buying the stock and paying an associated
Selling options work best when the stock doesn't have much downside
and options have a high time premium.
==I can sell uncovered (cash covered) puts in my IRA, but not uncovered
A covered put would require you to be short the stock and a covered call
requires you to be long the stock.
My broker charges a commission when I sell a put, and if it is in the money,
expires, and is exercised I'm also charged the commission for the purchase
of the stock
If you sell an uncovered call at a $ 5 strike price and the stock goes up to
$ 100, you could lose $ 95, but if you sold a put on that stock and it went
to zero you could only lose $ 5.00. That is why a broker can allow you to
sell puts, but will only allow you to sell COVERED calls.
The problem with these sorts of schemes is that you are going head to head with
the trading floors of the investment banks. The question you need to ask
yourself is "If this is so good, why aren't they doing it and taking all the
Those guys have got armies of MBA's and quants and rooms full of computers
looking for these kinds of opportunities. You need to figure out how you can
One doesn't have to make more than they make, to profit. Garbage in,
garbage out, still is true, as the recent financial crisis has shown,
The 1987 Black Monday bankrupted a lot of guys who had open puts on
the indices. Since then, put premiums have been w-a-y higher than ever
A cash-covered put means there is sufficient cash in the account to
purchase the stock, if it is assigned. It is possible to pick up
single-digit percentages selling cash covered puts, but for me, I'm
always ready to take the stock, and the reverse with covered calls.
This is very different from Diogenes' trading strategy.
Diogenes might look into spreads (most of the 'pros' do, to cap
downside). The CBOE sells a definitive CD. The profits shrink, as
well. But in trading, the real trick is to be nimble, recognize being
wrong *immediately*, and manage cash. Those black swans have very hard-
hitting wings as Mr. Carreiro succinctly points out.
As someone who does about four option trades a month, and who has
consistently made money at it for years, I can say your basic premise is
incorrect. Options are priced to be a *zero-sum* game. All things being
equal, if you sell puts (in or out of money, long or far), they are priced
in a way that if you hold to expiration, on average, you will make zero.
In practice, as a retail buyer or seller, you will not realize a zero sum
because of the illiquidity and high spreads for most options.
So if you sell puts and expect statistics to reward you, you are in for a
surprise. 70% of the time statistics will reward you and 30% of the time
statistics will give you a whack on the head. :) Overall, you won't
average out in the positive, particularly if you do it for a long enough
period of time.
Averages are benign, but the extreme standard deviations can wipe you out
completely. Most people who sell premium make the mistake of not sizing
the position correctly, and that can lead to bankruptcy quickly. In sizing
a position, you should assume that that the stock will be assigned to you at
the strike price, and that you are at risk to lose 100% of that stock
investment (just as you would be if you bought the stock outright). For a
small portfolio, you might be willing to risk 5% of your equity in one
stock. So size the options you buy so that you are never exposing more
than 5% of your principal to stock or index you are going to be forced to
buy if things go bad. I've seen people playing options put 20% of their
equity into just the purchase price of a short option position, not
realizing that if the stock collapses they are going to realize a loss on
that position that exceeds their entire net worth. It seems like an
obvious point, but unfortunately options seem to attract a large component
of people with addictive gambling personalities who simply don't understand
how to calculate risk and reward. Options are extremely unforgiving to
There are probably dozens of valid methods for making money on selling puts,
but the only method that has ever worked for me is to calculate the value at
which I am willing to buy a stock, and then look for situations where
selling a put lets me buy it much cheaper than that. For example, one
position I am watching now is for a commercial construction materials
company that was refinanced recently, and the new investor massively diluted
all the common shareholders. The new investor is buying in around
$2/share. It's common in such situations for the stock to sell down close
to the price the investor paid, and sometimes to a lower price. With the
stock trading at $2, the March 2010 $2.5 strike put is likely to be trading
at around $1.20. So if you sell short that put, you are effectively
willing to buy the stock at $1.30. Assuming you believe the company was
worth the $2 the investor put into it, and that this represents a real
bottom value for the stock, you are able to get the stock at quite a hefty
discount by selling the long-dated put. Looking at it another way, you
are being paid $1.20 to put $2.50 at risk, in a stock that you believe won't
lose you more than 50 cents as a worst case. That's pretty wonderful
balancing of risk and reward no matter how you do the math.
If I think the stock has tremendous upside, I would just buy the stock. No
reason to limit my gain by selling a put. But if I'm bottom feeding on a
stock that I think will be challenged to rise quickly, selling a put gives
me a way to realize a super-deep-discount and then effectively close the
position at a better price just from expiration of the premium on the
option. That's an example where you invest based on fundamentals, and
exploit the fact that options are priced based on statistical movements.
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