Selling Puts: The Good, The Bad And The Ugly

Great Article.  For these examples am I assuming correctly that...

* an ATM put is bought each week regardless of market? 

* Each put is sold weekly if it's up?

* If a put is down it is held until break even or better, no new put is bought until the old is sold?

* What is the recommended life for the new puts being sold?  

Hi Crazy,

First, the article illustrated an ATM put being SOLD, not bought. But, I think that's what you meant, anyway.

The puts can be sold weekly, monthly or at whatever interval one wants. I sell them with weekly expirations and roll anew each week. Some might find it less troublesome to trade less frequently. The market dictates what works bets and the market doesn't tell us its secrets.

Now, one sells the put at expiry .. not before. So, weekly is sold every week and monthly every month, etc..

If the market drops below the strike of the put, when it is rolled, at expiry, it is rolled at the same strike, until the market works its way back up. Then the put is sold ATM.

The recommended life span is every week, selling and rolling a weekly. However, some would like to do less wrk and longer durations can work just fine .. but I wouldn't sell an option more than one month out.

Whatever one chooses, the important point to remember and execute s to not abandon when the market goes down, not "run scared" .. just hold the previous strike and have patience. Sometimes your patience will be rewarded in a week, sometimes a month and sometimes a year. But his is along term strategy and it requires sticking with it. Keep in mind it is a version of "buy and hold", except the "buy" is a put-write.

Thanks Ken,

Yes, I meant sell a put, not buy.  

Do you have a standard day Monday/Friday that you sell the weekly puts?

If you have a significant gain mid week, do you set a price target to get out early, or hold them until expiry regardless?

The roll is usually done on expiration Friday by closing the short puts and opening the next week short puts. Or you can do it couple days before expiration if thee is very little time value left.

On 11/3/2018 at 1:01 PM, Reel Ken said:

If the market drops below the strike of the put, when it is rolled, at expiry, it is rolled at the same strike, until the market works its way back up. Then the put is sold ATM.

I understand that it’s a bad idea to roll out and down if it has to be done for a debit, as this basically locks in intrinsic losses that can’t be recovered. But if there’s an opportunity to roll out and down one or two strikes (maybe not to ATM, but nearer to the money) for a net credit, is there a compelling reason not to do that? As long as it’s for a net credit, it increases the total extrinsic value received and doesn’t create an intrinsic loss. It also moves down the price above which the market needs to move to bring the trade back into positive territory. 

I know it’s not always possible to roll out a single week and down for a credit, but it’s often possible to do so if you go out two weeks. Since this is a longer-term process (as you said, it can take months or weeks to recover from a big drop in the underlying), why not take an extra week of risk if you can lower your strike for a credit?

Even during the big drop in October, I was able to do this with a put on QQQ for a credit without going out more than two weeks. I know the increase in IV helped make this possible, but if IV is lower, and thus premiums are lower, then aren’t you less likely to be in this situation in the first place (because low IV means there hasn’t been a big price drop recently)?

The main concern for me with not rolling down is the potential for early exercise if the put gets too far ITM. I understand this isn’t a concern if you’re trading SPX options, since they’re European-style and can’t be exercised early. But for SPY, if you keep holding a strike that’s deeply underwater, the put may get exercised prior to expiration unexpectedly, and then you’re guaranteed a big intrinsic loss, no? Pushing things out a week or two and down a strike or two, for a credit, would seem to substantially decrease the risk of early exercise. Or am I missing something?

Hi Azov

One makes judgments and wins or loses ... so there is no absolute answer.

Rolling out a few weeks can work .. here's another option....

On a big drop, the likelihood of a bounce of more than 3% is slim. Additionally, most big bounces occur within a few weeks of a big drop,

So, one should be willing to sacrifice extrinsic for the first couple of weeks after a big drop and "hold". But, if the drop was, say 5%, one could go 3% ITM rather than hold and play favorable percentages.

After a few weeks, if he bounce hasn't occurred, one can , once again, lay the odds and go 2% ITM.

Now assignment is always a potential problem with equity options. It becomes more of a problem as extrinsic disappears. But if there's no extrinsic, it's safe to toll out and garner some. But, one must be especially careful around the ex-div date as the extrinsic is illusionary relative to the dividend.

Just to be clear on this, you are really selling put very deep in the money if the market drops a lot? For example in January of '18 SPY dropped 35 points, are you going to hold the strike and sell puts that are 35 points in the money? I noticed that currently puts that are 30 points in the money have a huge bid/ask spread (several dollars) and only .30 in extrinsic value.

Just wanting to make sure I understand the method here.

Hi MikeCl,

On a huge drop, like we've recently seen, nothing is easy. One could lower the strike, but I would keep it 3% ITM, awaiting a bounce and keep walking it up. One has to use some judgment and hope they are right. With vol as high as it has been, 3% ITM still generates reasonable extrinsic.

It is always been my feeling that as long as fundamentals are in tact --- and they still seem to be --- recovery will come --- it's just "when" not "if".

That said, there's really no play book for what we've just seen. Historic drops and historic rises in a matter of weeks.

Any data on the draw downs in Jan and Feb -18

"Hold the strike" is very interesting put write strategy. @Reel Ken what do you think, is it possible hedge this strategy without hurt the basic idea and do smaller drawdowns? maybe buy some tiny or long volatility (vxx)?

Hi Tamas,

Of course one can compliment the strategy. In fact, what I've been doing is selling calls against the VIX. It is certain that the VIX is unsustainable at 40 and will come down. It's just a question of when. So, as long as one is able to stay yje course and hold the strike against the VIX on a surge, it's about as certain a winner as there can be. Patience is  the key.

Reelken

Interesting article. I'm wondering how the 'hold the strike' strategy handles assignment. Do you avoid assignment altogether by closing at a loss near expiration or maybe write covered calls at the 'hold strike' price with the assigned shares?

1 minute ago, Guest Mike said:

Interesting article. I'm wondering how the 'hold the strike' strategy handles assignment. Do you avoid assignment altogether by closing at a loss near expiration or maybe write covered calls at the 'hold strike' price with the assigned shares?

You can always roll when time value becomes very small and not wait for assignment. If you are assigned when there is still more than 5-10 cents of time value, it's actually a gift - just close the share and sell the following month puts.

Also, for bigger accounts, SPX can be used instead of SPY to avoid assignment risk.

Lets say - you sold ATM 290 put weekly - next friday market crashed to 220 ( it is rear but possible , see march 2020) you are in debit - 50 x100 = -5000 , you are holding the strike and rolling to next week 290 you got credit 5000 but almost no time value -  what if the market in prolong decline - this strategy will bring you to financial ruin , unless you got huge account, at the end you have to  take your losses

1 minute ago, Peter from Richmond Hill said:

Lets say - you sold ATM 290 put weekly - next friday market crashed to 220 ( it is rear but possible , see march 2020) you are in debit - 50 x100 = -5000 , you are holding the strike and rolling to next week 290 you got credit 5000 but almost no time value -  what if the market in prolong decline - this strategy will bring you to financial ruin , unless you got huge account, at the end you have to  take your losses

Yes, but your loss is still less than just holding SPY. As long as your position sizing is okay (number of contracts equal to number of shares x 100 of SPY) it should perform no worse than just holding SPY.

that is true , however the cost of trade excluded from this theory , and it can be substantial difference betweek bid/ask when deep ITM

Interesting article. 

I am thinking that this outperformance of the hold strategy vs SPY is enough to include a long 1 year out put ( 5% OTM) , similar to the Anchor Strategy. And still make spy returns while being hedged 

Does this make sense? 

This is what Anchor does, yes.

@Kim A question I asked already on the Anchor Trades forum, but @cwelsh still seems to be in the back test phase with this.

Is XSP a better alternative  instead of SPY  for Holding ATM strategy because of 

1. Same margin requirements  (Smaller portfolio's)

2. No assignment risk!!!

Yes, @Jesseis actually using XSP for the momentum portfolio. Should be fine, and no assignment risk is a big advantage. Liquidity is not as good as SPY (very few products can compete with SPY in terms of liquidity), but still very good.

8 hours ago, Robby said:

Interesting article. 

I am thinking that this outperformance of the hold strategy vs SPY is enough to include a long 1 year out put ( 5% OTM) , similar to the Anchor Strategy. And still make spy returns while being hedged 

Does this make sense? 

5 minutes ago, Kim said:

Yes, @Jesseis actually using XSP for the momentum portfolio. Should be fine, and no assignment risk is a big advantage. Liquidity is not as good as SPY (very few products can compete with SPY in terms of liquidity), but still very good.

@Kim Thank you 

One other question: In this diagonal set-up, to which strike and when it is best to roll the Long Put @ expiration time if your short put of the last week/month is still deep ITM. Do you hold the original strike price or roll it to the 5% below the future strike price?

According to Reel, we always roll to the same strike. 

On 12/26/2020 at 7:54 AM, Robby said:

Interesting article. 

I am thinking that this outperformance of the hold strategy vs SPY is enough to include a long 1 year out put ( 5% OTM) , similar to the Anchor Strategy. And still make spy returns while being hedged 

Does this make sense? 

19 hours ago, Kim said:

Yes, @Jesseis actually using XSP for the momentum portfolio. Should be fine, and no assignment risk is a big advantage. Liquidity is not as good as SPY (very few products can compete with SPY in terms of liquidity), but still very good.

@Kim Thank you 

One other question: In this diagonal set-up, to which strike and when it is best to roll the Long Put @ expiration time if your short put of the last week/month is still deep ITM. Do you hold the original strike price or roll it to the 5% below the future strike price?

19 hours ago, Kim said:

According to Reel, we always roll to the same strike. 

THE GOOD??

I back tested Reel's theory  starting the 27th of Dec 2019 ending 18 Dec 2020on ONE using as start a 3 Jan 2020 Delta 20 short put and a Long put 1 year out 5% below the strike price of the Delta 20 put and held the strike in times of Sorrow which, as you can imagine, were many this year. Rolling  to Delta 20 weekly when price above the last short put strike price. Is this result for real? Used only XPS

29 minutes ago, Windeon said:

 

@Kim Thank you 

One other question: In this diagonal set-up, to which strike and when it is best to roll the Long Put @ expiration time if your short put of the last week/month is still deep ITM. Do you hold the original strike price or roll it to the 5% below the future strike price?

I back tested Reel's theory  starting the 27th of Dec 2019 ending 18 Dec 2020on ONE using as start a 3 Jan 2020 Delta 20 short put and a Long put 1 year out 5% below the strike price of the Delta 20 put and held the strike in times of sorrow. Rolling  to Delta 20 weekly when price above the last short put strike price. Is this result for real? Used only XPS

Well, I just did a quick calculation. Your long put initial cost was around $1,300. Selling 20 delta puts provided you initially around $150 credit, after volatility spike in March you would get around $300-400 credit. Holding the strike means that all short put rolls were done for a credit. Of course during down times the credit was very small, but still.

Now, your chart shows $2,783 gains. The long put expired worthless, so to get to this gain, your short puts had to bring total credits of over $4,000, or $333 per month. Sounds a bit high, considering that during down months the credit was very low, but not completely unreasonable. I will try to do the same backtesting later.

@Kim The profit is on the absolute risk, which was according to ONE $3651 and not on the price paid for the diagonal

When testing I saw Deltas of 60+ and losses of  > 50% passing by when holding the strike. I assume that by holding the strike  you receive a lot of credit from your roll which will lessen your overall loss, together with the workings of the long put in your favor in down times. Is this correct?

So first, it would not be correct to measure the gains as return margin/risk - the risk could be much higher than estimated. The correct measurement would be return on "notional exposure", not margin (this is the number of contracts we would trade). In our case it's around $33,000. So assuming your numbers are correct, we get return of less than 10%, not 77%.

To answer your question - yes, the advantage of "holding the strike" is that we never realize a loss, so we do much better during the recovery. The disadvantage is that we get much less extrinsic value (close to zero in fact after a big selloff), and if the recovery takes many months, then selling ATM or OTM strikes would be better.

@Kim I'm a little confused. I understand the notional exposure of around $33,000. But how much money do you need in  an account to place this trade. Does the long put have no effect on the margin impact? If you do not need $33K in your account, why do you have to measure your profit/loss against $33K if you never had it? What am I seeing wrong?

It's a matter of how much risk you are willing to take. The initial margin is around $3k, but it grows significantly as the underlying goes down. Yes, the long puts have an impact, but according to ONE, the margin reaches around $15k at some point. So if you did it while having only $3k in your account (initial margin), you would get a margin call very quickly. 

When selling naked puts, the conservative approach is to have x1 notional exposure. If you want to be really aggressive, maybe x2, but no more. Too many traders blew their accounts by having too much leverage.

Yes, I saw that happen while testing and was wondering why.

Thank you for the explanation

Thanks for this excellent article that I have just seen. As I understand, if the underlying price finishes above our sold strike, our next put sale is at the new higher ATM strike. We didn't make any gains on the way up for the distance between the old and new sold strikes and yet, after the new put sale, we are exposed to losses in that range.

I was wondering whether there is anything we should/could try to do before expiry to capture some of the available gains when the underlying price first goes up through our original sold strike?

I don't know if @Reel Ken is still following this article, so I will try to answer.

First, you are correct that big swings are the main enemy of this strategy. You catch most of the losses on the way down, but only small part of the gains on the way up.

What we can do?

First, we can roll early and not wait to expiration. We can set a rule to roll the short puts when we can close the existing puts around 20% of their original value (for example). So if we sold at $1.00 credit, we will close at 0.20 debit.

Second, we will sell slightly ITM instead of ATM to catch more gains on the up move.

@cwelsh does both in Anchor.

Third solution would be what Reel suggests which is hold the strike, to avoid taking the loss on the way down.

Hi! congrats for your articles! are you still run "hold the strike" strategy this year? 

@Reel Ken @Kim Excellent article. I like how it was shown how "ATM" did better than SPY in bear markets, but how did "ATM Hold" do in bear markets compared to those two?