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Today I’d like to discuss the ideal setup for selling puts.
Before I get started, I wanted to remind you that I’m focusing this week and next entirely on put-selling. I think we’re in the middle of an interesting time in the markets – and it’s time to look at the basic strategies that can work in good markets and bad.
That’s also why I’m hosting a live put-selling training event tomorrow. Click here for more details.
As always, you should never sell puts on something you wouldn’t want to own…
Remember: Selling a put obligates you to buy shares of a stock or ETF at your chosen short strike if the put option is assigned.
And sometimes the best place to look to sell puts is on an asset that’s near long-term lows.
The rationale is this: If something at 52-week lows falls further, you’d be fine owning it at even lower prices. If not, you simply enjoy the easy income.
And there’s an added benefit: When an asset is selling near long-term lows, it will typically have higher implied volatility, which acts like an added boost to the price of the put.
Case in point: I was sifting through my charts today and discovered an interesting opportunity in the iPath S&P 500 Short-Term Futures (NYSE: VXX). If you look at the chart below, you’ll notice that VXX is currently oversold on a short-term basis.
As an options trader, particularly one that prefers to sell options, this is the type of setup that I look for in a trade. The RSI is oversold over several different time frames, (2) and (5), which means that there’s a good chance that a mean-reversion move or reprieve is right around the corner. As a result, I want to sell a few puts on the volatility ETF.
An Exercise in Selling Puts: VXX
Selling a put obligates you to buy shares of a stock or ETF at your chosen short strike if the put option is assigned.
For example, let’s say you wanted to buy VXX, but not at the current price of $11.11. You prefer to pay $10.
By selling the August 10 puts you can bring in approximately $0.31, or $33 per contract. In this instance, you are selling the put with the intent of buying VXX for $10 if, at expiration in roughly 30 days, the stock is trading at or below $10.
Selling the August 10 put requires you to have $1,000 of cash in your trading account.
If not cash-secured, selling puts only require 20% of the $1,000 or $200, but retirement accounts and certain brokers require the puts to be cash-secured. And in this case, that would be the $1,000.
The return on the trade is 3.1% in roughly 30 days, or 37.2% annually.
This lines up exactly with my goal of bringing in between 1% and 3% selling puts each month.
And if the puts were not cash-secured, the return would be significantly higher.
As you can see from the same options chain below, you have other strike prices where you can sell puts. If you choose to sell a strike closer to the current price of the stock – say, $10.50 – you could bring in even more premium (roughly $54) but the probability of success goes from 69.54% for the 10 puts to 58.15% for the 10.5 puts. So, you do have to make a few decisions as to how much risk you are willing to take based on the strike you choose.
Back to our example: I prefer to sell the August puts for $0.31. The $31 is ours to keep regardless of what occurs with VXX.
If the stock closes at August expiration above $10, we keep the $31 and oftentimes repeat the process by selling more puts, maybe at the 10 strike or possibly at a different strike price. It truly depends on where the stock is trading at the time we sell the puts and how much premium we wish to bring in.
If the stock trades for less than $10 at August expiration we are assigned the stock for $10 per contract or $1,000 (100 shares per put contract sold). Oftentimes when this occurs I will begin to sell covered calls on the stock so there is an ongoing source of income coming in. I take this approach in one of my High Yield Trader portfolios, appropriately named “The Income Cycle.”
Speaking of High Yield Trader, Ian Wyatt and I will be hosting a webinar tomorrow at 12 pm ET.
During this live event, I’m going to show Ian how he can collect $120 in five minutes – in his personal investment account.
You can click here to register for this event.