Selling Cash Secured Puts (Notes)

Chen — Sat, 27 Nov 2021 01:53:15 +0000

Here are some notes I took from the book “Selling Cash-Secured Puts” by Alan Ellman. I’m already familiar with how options work and have read his book on covered call writing. These notes only cover the new concepts I learned. I strongly recommend that you buy both books (both are excellent) for more details and information.

Chapter 4: Selecting the Best Strike Price and Expiration Date for Put Selling

Defining our goals

Stock acquisition at a discount

Cost of Acquisition = Strike Price – Premium Collected
If unexercised, return = premium/cost * 100%
Target 2% to 4% return per month
If bearish, target lower end of the range and sell deeper OTM strikes (e.g. 1 to 2 strikes deep)
If bullish, target higher end of the range and sell near the money strikes

Income Generation Only

Sell OTM put
OTM put gives us lower return but reduces the chance of being assigned

Combining Put Selling with Covered Call Writing

Sell OTM put
If exercised, sell covered call

General Market Considerations for Strike Price Selection

If bearish, better to select deep OTM strikes.

To assess overall market tone, look at the 6 month S&P500 chart, 6 month CBOE VIX chart, and weekly economic reports.

We want the S&P 500 chart to be uptrending with 50D EMA > 200D EMA and VIX to be declining or stabilizing below 20.

Weekly reports include: Beige book, Business Inventories, Capacity Utilization Rate, Construction Spending, Consumer Confidence, Consumer Credit, Consumer Price Index, Durable Goods Orders, Employment Cost Index, Employment Situation, Existing Home Sales, Factory Orders, FOMC Meetings, GDP, Industrial Production, Initial Jobless Claim, ISM index, ISM non-manufacturing index, Leading Economic Indicators, New Home Sales, New Residential Construction, Non Farm Payrolls, Personal Income, Personal Spending, PPI, Retail Sales, U.S. Trade Balance etc.

Chapter 5: Calculating Put Option Returns

Formulas

If put is not assigned

ROO = \frac{premium}{strike - premium}

If put is assigned

Cost of Stock = Strike – Premium

Breakeven = Strike – Premium

If position is closed mid contract

ROO = \frac{premium - \text{cost to close}}{strike - premium}

ROO Target

Bullish: 2% to 4% per month

Bearish: 1% to 2% per month

Chapter 7: Portfolio Management

We need three lists to manage and keep track of our portfolio:

watchlist of eligible stocks
list of open positions
list of closed positions showing profits/losses

Chapter 8: Exit Strategies

Refer to https://smarttradingstrategies.com/covered-call-writing-notes-part-3/ for the definitions of the three zones.

Zone	Steps
Orange	If stock appreciates above strike price Buy back option when its value <= 0.2*original premium If stock is less than 3% below strike price Do nothing but monitor. The loss incurred (strike price – current share price) should be less than the option premium. If stock is more than 3% below strike price If the stock is weak (i.e. underperforming the market) or the market is weak and unlikely to recover, buy back the option at a loss. If stock gaps down significantly If the gap down is due to a serious issue (e.g. fraud investigation by SEC), buy back the option. Else, get assigned and sell OTM calls (but avoid selling during earnings months)
Blue	Buy back the option if premium <= 0.1*original premium
Black	If the option is ITM and you do not want assignment – If there is no upcoming earnings, roll out to the next month (same strike price) for a credit. – Else, buy back the option (should not be too expensive now). If the option is ITM and you want assignment Buy the stock and sell a covered call if there is no upcoming earnings report If option is OTM Let it expire worthless

Chapter 9: Exchange Traded Funds

Need not be concerned with earning reports
However, ETFs have lower implied volatility and hence lower premium and returns (target 1% to 2% per month)

Criteria

Outperform S&P500 over past 3 months
RS ratings of 60 or better
Average daily volume of at least 250k shares (3 month average)
Open interest of 100 contracts or more for near the money strikes
Not a leveraged fund

Free sites for ETF screening

Wall Street Journal
https://online.wsj.com/public/quotes/etf_screener.html
Market Watch
https://www.marketwatch.com/tools/etfs/html-adv-screener.asp
Morningstar (need to create account for free)
https://screen.morningstar.com/etfselector/etf_screener_version1.aspx

Select Sector Spiders

Select sector spiders (SPDRs) are unique ETFs that divide the S&P 500 into nine sector index funds. You can compare the relative performance of the funds and select the top 3 performing funds. The nine sector funds are

XLY (Consumer Discretionary)
XLP (Consumer Staples)
XLE (Energy)
XLF (Financial)
XLV (Health Care)
XLI (Industrial)
XLB (Materials)
XLK (Technology)
XLU (Utilities)

Inverse ETFs

Inverse ETFs (e.g. PSQ, DOG, SH, RWM) rise when market falls. Best utilized in strong bear markets rather than when there are minor corrections.

Implied Volatility

Implied volatility is the forecast of the underlying security’s volatility as implied by an option’s price.

Can be interpreted as the anticipated % change in either direction in one year.

For instance, if IV = 33, the market is anticipating a 33% price change in the underlying security in either direction.

Chapter 15: CCW vs CSP

Covered Call Writing	Cash Secured Puts
– Capture dividends – Max profit = Premium + Share Appreciation – Slightly bearish to bullish outlook – Must buy shares first – Early assignment is not an issue	– No dividends, but premium tends to be higher when there is a dividend distribution – Slightly bearish to neutral outlook – Must deposit cash first – Early assignment may be a problem when the stock crashes rapidly

Chapter 16: The Put-Call-Put Strategy

Suitable when you are bearish on the overall market or have a very low risk tolerance and do not want to pay full price for the shares before writing call options

Steps:

Sell OTM puts
If exercised, sell call option on this “discounter” stock

For step 1, we favour OTM puts in all market environments and go deeper OTM in extremely bearish market environments

For step 2, we favour ITM strikes in bear markets and OTM strikes in bull markets

call options – SMART Trading Strategies