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Establishing 84% Probability of Success Put Trades in Bear Markets

Selling deep out-of-the-money cash-secured puts in bear markets will provide us with additional protection to the downside in return for lower, but still significant, option returns. This article will highlight the use of Delta and implied volatility to establish a framework for executing such trades with n 84% probability of success.

 

What is Delta?

This is one of the Option Greeks. There are 3 ways to define Delta. The one related to this topic is the probability of the option expiring in-the-money (or with intrinsic-value) at expiration. If we sell a put option with a Delta of -16 (put value is inversely related to share price), we have (approximately) an 84% probability of avoiding exercise without exit strategies.

 

What is implied volatility (IV)?

This is a forecast of the security’s price movement as implied by the option’s price movement in the marketplace. Since IV is typically published an annual basis and based on 1 standard deviation, we must use a conversion formula or calculator (we have one, folks) to determine the expected price range of a stock or ETF during a specific contract cycle. Since IV is based on 1 standard deviation (accurate 68% of the time), it will be accurate 84% of the time on the lower and upper ends of the range (68% + 16%).

 

A real-life example with Jabil, Inc. (NYSE: JBL): IV on 10/19/2022

 

JBL: IV on 10/19/2022

 

The BCI Expected Price Movement Calculator (available to premium members) using an annual IV of 38.64%

 

Expected Price Movement of JBL Using IV

 

The spreadsheet guides us to a breakeven price point of $54.06 (circled in red). This will include the strike price – the put premium. As it turns out, the strike with a Delta closest to 16 was the $55.00 strike which had a Delta of 18. No other strike was closer.

 

Broker platform showing a bid-ask spread of $0.80 – $0.95 for the $55.00 put option

 

JBL: Put Trade Entry Data

 

We will enter a put premium of $0.85 into our BCI Trade Management Calculator to establish initial calculations and exit strategy price points.

 

JBL: Initial calculations using the BCI Trade Management Calculator

 

JBL: Initial Put Calculations

 

Note the following for this 84% probability of success trade:

  • Breakeven price point is $54.15 (yellow cell in the middle of the image), approximating our target of $54.06 (expected price movement calculator)
  • The 31-day initial return is 1.57%, 18.48% annualized (blue cells)
  • If we allow the put to be exercised (if ITM at expiration), we will have purchased JBL at a discount of 10.94% from the price at trade initiation (brown cell)
  • The exit strategy price points are calculated in the yellow cells at the bottom of the image

 

Discussion

Defensive put-selling strike selections can be determined by using Delta and/or implied volatility. The use of these data points can assist us in establishing (approximately) 84% probability successful trades.

 

Premium Member Benefits Video

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Your generous testimonials

Over the years, the BCI community has been incredibly gracious by sending our BCI teaemail testimonials sharing stories as to what our educational content has meant to their families. Moving forward, we have decided to share some of these testimonials in our blog articles. We will never use a last name unless given permission:

Alan & Barry,

Happy holidays to the entire Blue Collar investor team and all the people along with Alan and Barry involved in the making and distribution of this amazing video product that helps us fledgling traders in our journey up this trading mountain!

Thank you, Alan and Barry. You have helped me grow as an options trader over the years!

Steve

______________________________

Upcoming events

To request a private webinar for your investment club, hosted by Alan & Barry: [email protected]

 

1. Money, Markets, & Monetary Policy Virtual Expo 

April 11th, 2023

2 PM – 4 PM ET

Master Class (paid event to The Money Show)

In depth presentation on selling cash-secured puts

Registration link to follow.

 

2. Wealth365 Summit

Tuesday April 18th

10 AM ET – 11 AM ET

Covered Call Writing Dividend Stocks to Create a 3-Income Strategy 

Covered call writing is a low-risk option-selling strategy that generates weekly or monthly cash-flow. By mastering the skill of strike price selection and adding dividend distributions, a potential 3-income strategy can be crafted with a goal of beating the market on a consistent basis.

Bonus topic: An introduction to the BCI streamlined approach to covered call writing creating a more user-friendly and time-efficient path to this low-risk option-selling program.

Topics covered in this webinar include:

  • Strategy analysis
  • Option basics
  • What is covered call writing?
  • Dividend distribution
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  • Option selection
  • Trade management

Real-life examples will be highlighted with Dow 30 stocks using option-chains and calculation spreadsheets.

Attendees will have the opportunity to participate in written Q&A during the entire webinar.

Register here.

 

3. Your Mid-Year Portfolio Review Virtual Expo 

June 27th – 29th, 2023

Specific time, date, topic & description and registration link to follow.

 

Alan speaking at a Money Show event

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

25 Responses to “Establishing 84% Probability of Success Put Trades in Bear Markets”

  1. Barry March 18, 2023 7:28 am
    #

    Hello again Alan.

    Thank you for recent conference on SPDRs.

    I plan on starting next Monday using the 4 best. I will do weeklies as I believe the profit should be greater than monthlies.

    As I will only have 4 positions the amount of time will not be unreasonable.

    The question is: How do I use the 20/10 strategy with only 1 week?

    Thanks again.
    Barry

    • Alan Ellman March 18, 2023 7:33 am
      #

      Barry,

      When using weekly options, the 10% BTC GTC limit orders apply. It would the same as using monthly expirations and changing from 20% to 10% in the final 2 weeks of a contract.

      Alan

      • Barry March 18, 2023 3:08 pm
        #

        Alan,

        If you employ the 10% BTC for a weekly does it make sense to then roll out to the monthly expiration?

        Barry

        • Alan Ellman March 19, 2023 8:25 am
          #

          Barry,

          You can certainly do this. However, my personal preference is to have each of my option portfolios with the same expiration date. This makes management much more user-friendly and time efficient.

          For those with accounts with a small number of positions, integrating weekly and monthly positions into the same portfolio may be manageable.

          We should start by identifying all the parameters of the strategy we are employing (Weeklys, Monthlys, initial time-value return goal range, moneyness of options, calls or puts etc.) and adhering strictly to those parameters.

          Alan

  2. Barry B March 18, 2023 10:08 pm
    #

    Premium Members,

    This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member site and is available for download in the “Reports” section. Look for the report dated 03/17/23.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them on The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:

    https://www.youtube.com/user/BlueCollarInvestor

    Reminder: Premium members are grandfathered into your current rate and will never see a rate increase as long as the membership remains active.

    Best,

    Barry and The Blue Collar Investor Team
    [email protected]

    • Alex Polanco March 19, 2023 11:42 am
      #

      Hi Barry, Alan. I was not able to find the Blue Chip report for April contracts in the member site. Will you post it in the following days? Thanks as always.

      • Alan Ellman March 19, 2023 5:09 pm
        #

        Alex,

        The Blue Chip Report for the April 2023 contracts has been uploaded to your member site. Look in the “resources/downloads” section of the member site under “B”

        Alan

  3. Donna March 19, 2023 1:42 am
    #

    Alan,

    Do you play the bid/ask spread in regards to the 20%/10% Guideline?

    Thank you.

    Donna

    • Alan Ellman March 19, 2023 8:30 am
      #

      Donna,

      Yes, we can leverage the “Show or Fill” rule with all option trade instructions to our brokerages.

      As an example, if the buy-to-close (BTC) spread is $0.10 – $0.30, I may set a BTC limit order at $0.25.

      As a guideline, we set the orders at slightly below the midpoint when selling and slightly above when buying.

      Alan

  4. Frank March 19, 2023 2:12 am
    #

    Hi Alan,

    I’m going though the new book/spreadsheets.

    Two questions – Are there reasons for waiting until Tues to set up the program each month (for example – expected hot zones like JP speaking..)?

    If there are enough contracts in OI and the spread is greater than .30 (as is the case with XLC based on the options chain today, do you move down the list to the next best ETF that qualifies?

    Thank you,
    Frank

    • Alan Ellman March 19, 2023 11:14 am
      #

      Frank,

      1. When I state, “the Monday or Tuesday after expiration Friday”, my focus is early in the next contract cycle. Monday may not be a convenient day or rare risk factors like you allude to. Generally, I enter my trades on Monday after expiration Friday between the hours of 11 AM ET and 3 PM ET.

      2. I would focus in on the best performers and view the option chains during normal trading hours, after the 1st hour of trading has passed. After hours option-chains are often incomplete. There will rarely be a liquidity issue with these Select sector SPDRs.

      Alan

  5. Venkat March 19, 2023 6:31 pm
    #

    Hello Alan and Barry

    Hope you are enjoying well deserved weekend with dear ones.

    I have a question?

    For ETFs selected this week,

    XLK, XLP, XLU and XLC the bid ask and open interest is not in the ranges
    .30 and 100 for any of the preferable strikes.

    In such scenario I will not be able to consider them.

    What is your comment and how to go about.

    Please clarify and oblige.

    Regards
    Venkat

    • Alan Ellman March 20, 2023 5:42 am
      #

      Venkat,

      Check the option chains today after 10:30 AM ET. That’s when market-makers start setting reasonable spreads, after they evaluate market direction.

      Alan

  6. John March 19, 2023 7:17 pm
    #

    Alan,

    In the JBL example in this article, is your EM calculation different from EM= (P*ATM IV*(DTE)^1/2)/16?

    The calculated EM seems to be approx. right for DTE = 20. For DTE =30, isn’t EM = $8.04?

    Thanks for the clarification.

    John

    • Alan Ellman March 20, 2023 5:46 am
      #

      John,

      The formula inherent in the spreadsheet is accurate:

      Formula:

      Approx. Expected (+/-1 Standard Deviation) Price Move =

      ($Stock Price)*(ATM IV)*[√((# Calendar Days to Expiration)/365)]

      Note: √ is symbol for the “Square Root”

      Alan

  7. Dan March 20, 2023 1:35 am
    #

    Dr. Ellman:

    Thank you for your weekly emails. I use them together with the information in your books (I have three of them) to analyze my own trades. I think there is a small discrepancy in today’s (3/19/23) analysis of Cash Secured Puts. The first screenshot shows the number of days in trade equal to 30. The third screenshot uses the same dates but shows the number of days as 31. If you use the Excel function DAYS(end_date,start_date) it returns the first screenshot number of 30 days. The only other number that changes is the annualized return = 19.10%.

    Best regards,

    Dan

    • Alan Ellman March 20, 2023 5:53 am
      #

      Dan,

      Excellent catch!

      When we developed our latest and best calculator/spreadsheet, The Trade Management Calculator, I used a formula that included the day of the trade in calculating the # days to expiration. A case can be made including it or not, but I felt it to be a bit more accurate with its inclusion.

      I also asked my team to update the other spreadsheets to include the additional 1 day in annualized return calculations and we are in process of doing so. The Expected Price Movement Calculator will be updated very soon, replacing the current version located on our premium member site.

      Alan

      • Alan Ellman March 20, 2023 11:33 am
        #

        I was notified by my team that the updated version is already up on the member site … Alan

  8. brad March 21, 2023 10:27 am
    #

    Alan, Barry,

    Pretty serious question here. This morning I entered the sector spiders. I use Tradier and they are pretty unfriendly on entering a buy write so I’m legging in (so to speak). My equities have all been filled.

    As I enter the near the money calls to sell to complete the covered call, what happens if the option gets hit and the stock gets called away?

    I’m pretty anxious for your thoughts and I know that they are not recommendation just suggestions in learning.

    Thanks in advance for a quick response.

    Brad

    • Barry B March 21, 2023 4:36 pm
      #

      Brad,

      The scenario that you mention is extremely rare. In trading covered calls since 2007, this (very early assignment) has never happened to me. If your stock is assigned, it typically will occur near the end of the options cycle, unless there is a dividend play and that typically does not happen with ETFs.

      Now…if your stock was assigned (called away) very early in the month, that would be good for you! This would mean:

      – Your trade plan was executed exactly as you planned it
      – You hit your target return early in the month
      – You are back in cash…in addition to your premium income
      – You can now deploy that same cash in another trade
      – Net/net…nothing to be concerned about.

      Best,

      Barry

  9. Alan Ellman March 22, 2023 5:23 pm
    #

    Premium members:

    This week’s 4-page report of top-performing ETFs has been uploaded to your premium site. The Select Sector SPDR section is now crafted to align with our streamlined (CEO) approach to covered call writing. The report also lists Top-performing ETFs with Weekly options, mid-week market tone as well as the implied volatility of all eligible candidates.

    Premium member video link:

    https://youtu.be/EXMO-KwZuJs

    For your convenience, here is the link to login to the premium site:

    https://www.thebluecollarinvestor.com/member/login.php

    NOT A PREMIUM MEMBER? Check out this link:

    https://www.thebluecollarinvestor.com/membership.shtml

    Alan and the BCI team

  10. Patric March 23, 2023 12:04 pm
    #

    Alan,

    I bought aapl at 150 sold the march 31st call at 152.50 the stock price today is hitting 160.00 yikes!

    What should I do?

    Patric

    • Alan Ellman March 24, 2023 6:52 am
      #

      Patric,

      If AAPL closes above $152.50 at expiration, you have maximized your trade as originally established. This includes the original option premium + $2.50 in share appreciation.

      Now, if your plan included retaining the shares for the next contract cycle, we roll the option out- or out-and-up prior to expiration. I, generally, start rolling my option about 2 PM ET on expiration Friday but it could be prior to that as well.

      If retaining AAPL is not important to you or the calculations do not align with your initial time-value return goal range (when rolling the option), then take no action and shares will be sold on Saturday after expiration Friday, the cash will be in your account, and you can start making plans for the next cycle. You can use the “What Now” tabs of our Trade Management Calculator or other spreadsheets for these results.

      When we establish our trades, we must also incorporate potential exit strategy plans prior to trade execution.

      Finally, if inherent in your trades, AAPL is a long-term holding, then the strategy you should employ is “portfolio overwriting” where we use deeper out-of-the-money call strikes.

      Keep in mind, it looks like you will be maximizing your trade.

      Alan

  11. Reggie March 24, 2023 1:43 am
    #

    Alan,

    Does the TMC calculator keep track of realized stock loss and apply that on the next trade if the same stock is traded again?

    Or does it just keep track of gains and losses for the portfolio as a whole?

    How does this work?

    Reggie

    • Alan Ellman March 24, 2023 7:14 am
      #

      Reggie,

      Our Trade Management Calculator does keep track of both legs of a covered call trade.

      The spreadsheet will generate initial trade & portfolio returns, exit strategy entries, when implemented, and then final stock gain/loss and option gain/loss per trade and also for the total portfolio.

      Here are links to explanatory videos:

      OVERVIEW

      https://youtu.be/AFj_2Z3nb6Q

      DETAILED

      https://youtu.be/KEjZK-krjc0

      Alan