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Put Call parity will nearly always hold on liquid instruments not factoring in transaction/mkt friction costs, I can tell you your returns are going to be pretty damn close to covered calls (it's the same position)... and if it isn't in your MC sims, re-evaluate your cash flows.

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Isn't there significantly different in tax treatment for the same payout?

Deeply out of the money Puts will sell for far less than deeply in the money Calls. I also need to take into account the stock's dividend, which ins't accounted for with the put method, but is accounted for with the call method.


What are your thoughts on "cash" (really bond etf and bond mutual fund) backed Put writing? If I took the "margin" or naked part out of this concept?

Am I wrong to think that "cash" backed out of the money Puts would add between 1% to 2% to the bond fund returns? It also sets me up to purchase the security if the market drops.


Thank you all again.

Also, am I wrong on the mechanics of an exercised put?

I know that they aren't like a limit order that is executed if the price drops below my limit price (in the case of a buy). Should I expect that a put is exercised (shares assigned for cash) close to when it is about to mature? Does it just depend on the holder of my Put?

Example if I write a put contract for SPY at $250 a strike price which is 10% to 15% out of the money. SPY drops to $245, should I expect that the Put would will be exercised close to the expatriation date?

RogerEnright said:

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Also, am I wrong on the mechanics of an exercised put?

I know that they aren't like a limit order that is executed if the price drops below my limit price (in the case of a buy). Should I expect that a put is exercised (shares assigned for cash) close to when it is about to mature? Does it just depend on the holder of my Put?

Example if I write a put contract for SPY at $250 a strike price which is 10% to 15% out of the money. SPY drops to $245, should I expect that the Put would will be exercised close to the expatriation date?

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A sold put ITM can be exercised at anytime by the owner

Edit: my experience has been that it has not been exercised until the last week of expiry or if the ITM move has been significant

Thanks.

I sold a couple contracts just before Trump and China added volatility.

Really I think there are is a good bit more of my fixed income portfolio that I would like to start selling out of the money puts for the wife and me. As OldArmy01 pointed out, I need to get some experience with this portfolio and then I could broaden out this strategy.

I am pretty negative on the equity markets and have been overweight fixed income for some time. If we can add 1 to 2% annually by selling "fixed income" backed puts with attractive strike prices, then this could be very additive to the meager interest that we are currently earning.

I will hold off on the true naked puts for now.

A sold put cannot be excercised until expiration date

Also, at least sell put credit spreads, you still collect premium and are hedged against a total catastrophe

dantes said:

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A sold put cannot be excercised until expiration date

Also, at least sell put credit spreads, you still collect premium and are hedged against a total catastrophe

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linkypoo


American Options Explained

American options allow the holder to buy or sell a specified underlying asset, at a strike price on or before a predetermined expiration date. Since investors have the freedom to exercise their options at any point during the life of the contract, American style options are more valuable than European options, which can only be exercised at maturity. In other words, the ability to exercise early carries an added premium or cost.

pacecar02 said:

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dantes said:

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A sold put cannot be excercised until expiration date

Also, at least sell put credit spreads, you still collect premium and are hedged against a total catastrophe

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linkypoo


American Options Explained

American options allow the holder to buy or sell a specified underlying asset, at a strike price on or before a predetermined expiration date. Since investors have the freedom to exercise their options at any point during the life of the contract, American style options are more valuable than European options, which can only be exercised at maturity. In other words, the ability to exercise early carries an added premium or cost.

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Most stock options are American options, while indexes are generally European. You can always trade ETF options if you want American options, though. Of course, either style is suitable for losing your ass.

I am writing to give you an update.

Honestly, selling naked puts feels like handling a loaded gun.... It shouldn't be a problem if I handle it with care.

Most of this is just because I am still new to selling puts.

Update
- Sorry in advance if this is hard to read. I really don't know the nomenclature of options.

I have expanded the put selling strategy to be used in 3 different portfolios that I manage (2 of which are mine, 1 is a family member's)


Portfolios
1. My speculation account which has about $117k in it currently and is about 25% fixed income.
- I am selling naked puts with an exercise obligation equal to about 35% of the value of this portfolio (about
$117k), which would get me to about 10% margin (or more in a depressed equities market) if exercised

2. A larger portfolio that I typically use for small private deals
- I am selling naked puts with an exercise obligation equal to about 70% of the fixed income value of this portfolio, so these puts are backed by fixed income bonds and mutual funds

3. A portfolio of a family member
- I am selling naked puts with an exercise obligation equal to about 50% of the fixed income value of this portfolio, so these puts are backed by fixed income bonds and mutual funds
- This portfolio sits at just under 40% equities and 60% fixed income; I am tasked with converting it to a 70% equities / 30% fixed income, but we are in no rush


Observations:
- I haven't had a Put exercise yet
- There is a real temptation to 1. Reduce the strike price is to increase the proceeds, so there is some struggle to stay disciplined, 2. Expand beyond SPY, but option bid ask spreads are pretty unattractive in many other securities, 3. Sell puts beyond the "fixed income backed" level of the portfolio so this process would really be naked at that point
- Optimizing price and annual return is time consuming; I find I am willing to give up a little annualized return on premiums to extend the exercise date a little; therefore not optimizing the decay
- I really need to understand the probabilities and Greeks better and I am having a hard time finding good books or papers
- Trying to sell Puts other other securities beyond SPY is hard. These less liquid securities have significant bid ask spreads for out of the money strike prices. It seems like I am trading with a market making computer at that point;
- The securities that I have traded beyond SPY include: VBR, NUE, BRKB, VB. They all fit into desired tilts of the portfolios


If I can find time, I would like to write out a bit more rules for this strategy for each of the portfolios:
1. What is the target annualized return for puts at different out of the money levels (e.g., 1.5% annual return for 20% out of the money)
2. How much should I sell at 10% out of the money, 20% out of the money, 25% out of the money etc.

If you executed this strategy today, how much premium would you collect on the puts?

I can see it as a way to earn a little extra return. My concern would be that the premium is unlikely to really "move the needle"...just guessing. And if you ever did get exercised, you would be exhausting your liquidity at a time of market upheaval when there might be a lot of bargains available.

chris1515 said:

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If you executed this strategy today, how much premium would you collect on the puts?

I can see it as a way to earn a little extra return. My concern would be that the premium is unlikely to really "move the needle"...just guessing. And if you ever did get exercised, you would be exhausting your liquidity at a time of market upheaval when there might be a lot of bargains available.

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You nailed many of my concerns.

"move the needle" is somewhat subjective, but it doesn't have to be. With my conservative investing, adding just 50bps of annual income for the fixed income portion of the portfolio is "material" over the long term if it doesn't take too much time to implement and doesn't add too much risk. I view this is similar to me choosing an index over an actively managed fund to reduce the 50bps of costs.

On trades where I want the stocks / ETF soon (e.g., NUE, VB etc.) I will set a strike price at around 10% below market value and the annualized returns could be in the 2% to +3% range.

On SPY, I typically try to discount the strike price to the current price somewhere around 25%, but I may start adding a 35% discount level as well. I find that I get anywhere from 1.5% to 70bps annualized return for these trades.

"exhausting your liquidity at a time of market upheaval when there might be a lot of bargains available"
- This certainly is why I would like to write out constraints to this approach, e.g., how much of the fixed income portfolio I would like put at risk and at what strike price for what annualized return on the premium. Also, I spend as much time worrying that the option holder WONT exercise when the option is only slightly in the money. I imagine if we experienced something like the 1987 crash, I wouldn't have much in the way of new equities.

This is still a working progress. I will let you know as I learn more.

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The plan (I am still optimizing the amount of leverage):
1. Get the fund up to about $150k
2. Move the account (in process) to Interactive Brokers (lowest margin rates)
3. Write $20k (sell) naked put options of SPY (seems to have the most option liquidity) at about two months periods at a strike price 15% below current market prices and write another $30k of put options at 25% below the market.

If the first 20k of options are exercised, I would sell the fixed income ETFs to pay for them, if the second 30k of options are exercised this will result in the margin debt that I am looking to add to this portfoli

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SPY is currently at $302, so if you're selling puts 15% below that, you're looking at ~$255.

Per Yahoo finance, those puts for a Sep 20 expiry are around 34 cents.

$20K/$255 would mean 77 "options" (a standard contract is for 100 shares, can you do smaller?)...at 34 cents that would net you ~$27 (before any commissions and any taxes on gains).

The ones 25% below market would be even less.

Is this what you're looking at?

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SPY is currently at $302, so if you're selling puts 15% below that, you're looking at ~$255.

Per Yahoo finance, those puts for a Sep 20 expiry are around 34 cents.

$20K/$255 would mean 77 "options" (a standard contract is for 100 shares, can you do smaller?)...at 34 cents that would net you ~$27 (before any commissions and any taxes on gains).

The ones 25% below market would be even less.

Is this what you're looking at?

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Read all the way through to ask this question and it's the last post

Is there any premium available that far below market?

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SPY is currently at $302, so if you're selling puts 15% below that, you're looking at ~$255.

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Yes, so it is hard to make the numbers work when you price at the day of the 52 week high.

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$20K/$255 would mean 77 "options" (a standard contract is for 100 shares, can you do smaller?)...at 34 cents that would net you ~$27 (before any commissions and any taxes on gains).

Is this what you're looking at?

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Exactly. Contracts are 100 shares as you indicated. I show $0.35 / bid for the Sep 20, 2019 bid.

Sep 20 to today represents about 15% of the year. If you annualized the $34 or $35 then you are looking at just under 1% return, which wouldn't hit my 1% to 1.5% threshold.

If I am going to only get 1% annualized, I would hope that I would be selling with a strike price closer to the 20% to 25% off the 52 week high.

Note that if you look at the SPY 255 puts for June 19, 2020, the premium is $5.21. This represents just under 90% of the year for an annualized premium of 2.29%.

There is a lot for me to look at and I know I don't understand many components of options yet.

Also, when you get this far out (date / strike price ?) the option premium bid / ask spread aren't always real. Example when I try to trade, the bids vanish like it was out of Michael Lewis' Flash Boys.

Although SPY options are much better than most other securities that I have tried.

There are multiple banks / credit unions that offer over 2% for 1 year CDs. Why take any risk for half the return?

I thought you were looking for 1% for each 60 day investment.

aggiebrad94 said:

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There are multiple banks / credit unions that offer over 2% for 1 year CDs. Why take any risk for half the return?

I thought you were looking for 1% for each 60 day investment.

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The fixed income portions is funds or bonds that yield over 2% interest. Many money markets are over 2% as well. So with the 1.5%, it would be something more like 4% assuming 2.5% interest.

To rewind a bit, I would like to purchase more equities in each of the three accounts. The smallest account has about $117k that I wouldn't mind levering up and having over 100% equities in (maybe 140% if the price of equities were really low). The other two accounts have too much fixed income in them as well, but with Shiller Cape above 30, I am reluctantly investing into equities.

If I am waiting for more attractive equity pricing, some portion of the fixed income capacity that should already be in equities could be used to sell Puts for equities at attractive prices.

Take VB for instance; VB is a good fit for a couple of these accounts (not the smaller one). I sold 7 contracts for with a strike price of 143 for $1.99 / contract last week. That represents an annual 3.53% return on top of the interest that $100,100 ($143 * 100 * 7) already was earning.
The 143 strike price is really about 10% below the current $159 price for VB.

This is a perfect day to sell puts and to get better valuation for them.

As always, it should be options on securities that I would like to own at a certain price.

Your answer to Chris1515 suggests that options or at least puts are not just sensitive to immediate volatility, but also the direction of that volatility or move in the market, which makes sense from a human nature point-of-view, but I am not sure about historical data on which options are more likely to be exercised.

Also, based on your question, the learning curve for optimizing this strategy seems to be too steep / labor intensive for someone with only $150k portfolio. While a subjective statement, it seems to only be worth the time for people with over $500k of fixed income ready to back these puts.

Another observation, it seems like you should keep your money in a portfolio of high grade "longer term" bonds as the times that these puts are exercised will likely correspond with lower movements in interest rates, ostensibly maximizing the price of these bonds.

Update:
I have sold $16,174 of puts on about $1.5 million of fixed income / cash capacity so far and have had no exercises. Lessons learned so far:

1. There is significant behavioral "temptation" to write puts beyond bond / cash backed capacity. I initially struggled with this, and may have to struggle with it again when volatility hits.

2. I attempted to "stock pick" and find a specific company that I would like to own at an attractive price. My desire to own individual stocks tends to be shorter in duration than the options, especially as the equity price drops below the strike price.
a. E.g., Nucor

3. Volatility, volatility, volatility, especially during a bad day. As per my response to chris1515, this strategy doesn't make sense to execute at 52 week highs etc.
a. Currently I am targeting 2% annual income off of ~25% discounts on SPY. I set limit sell orders for puts on SPY and then wait. Hopefully they hit.

4. I find that the premium for short term (2 months) options not as attractive as longer term options on a $/day basis.

RogerEnright said:

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especially during a bad day.

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Today is a pretty bad day, or a good day to sell puts. I am now targeting 2% annualized premiums for the deeply out of the money puts that I sell.

To date (since I started this post) I have sold $22,108 in puts with no options exercised.

Haven't reread earlier posts, but if I'm recalling your thesis correctly you were doing this primarily to manage your entry point to equity exposure and improve the cash/fixed income return along the way. Is that correct?

Fixed income returns have been surprisingly positive YTD, and I suspect your incremental return from the written puts has made for a collective nice return. However, I'm curious what the market has done over the same time frame. If we are talking YTD, your return has likely paled in comparison to what could have been if you simply entered the market. Can you elaborate on how your calls are doing in this light?

Thank you for the question. It helps me to think through my thesis.

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Haven't reread earlier posts, but if I'm recalling your thesis correctly you were doing this primarily to manage your entry point to equity exposure and improve the cash/fixed income return along the way. Is that correct?

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"Manage entry point" is somewhat correct, although the amount of equity that I want to own is based on market valuation.

Rather than a 50/50 or 60/40 portfolio, shouldn't I be able to add some simple micro-econ into my portfolio construction? If the price of ice cream goes down I would eat more etc. I am willing to add a bit more equities into the portfolio during a market drawdown without too much market timing.

I likely over use CAPE Shiller; even Professor Shiller admits its limitations. But it is the primary way I think of market valuation.

If I am willing to adjust between 30/70 and 70/30 splits depending on valuation, then I think it should be ok for me to sell puts at certain discounts to the market. If we were at at 20 CAPE, I would feel more comfortable at 70% equities than at a 29 CAPE.

Again, I understand CAPE Shiller only has limited predictive ability over the next 10 years and many professionals argue that new accounting changes impact the E in P/E.

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Fixed income returns have been surprisingly positive YTD, and I suspect your incremental return from the written puts has made for a collective nice return. However, I'm curious what the market has done over the same time frame. If we are talking YTD, your return has likely paled in comparison to what could have been if you simply entered the market. Can you elaborate on how your calls are doing in this light?

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Very true about under-performing equities, although I imagine it would depend on which day you ask me. I am not sure comparing this portfolio to 100% equities is correct. If not, then what is the right level of equities to compare this to?

I don't play poker often, but when I do, I judge my play by how I played with the hand that I had based on what I knew, not on the results of that hand.

You have a great point though, I could miss the next 20 years of equity growth if I keep clipping coupons and selling puts for 1.5% to 2% annualized premiums.

I have not bought or sold calls lately.