How to Establish a Bear Market Cash-Secured Put Trade

click ↑ 4 Featured

In bear and volatile market conditions, we may opt to take a defensive posture with our cash-secured put trades. One technique to accomplish this conservative approach is to use implied volatility (IV) to determine an approximate trading range for the option contract expiration period and use a put strike near the low end of the range.

Implied volatility and projected trading range: Process

• Locate an at-the-money (ATM) put strike, and the implied volatility associated with that strike.
• IV is based on 1 standard deviation (approximate 68% accuracy). Of the 32% that falls outside this range, we are concerned only about the 16% that will fall below the low-end of the range. This creates an approximate 84% probability of avoiding exercise, or the strike expiring in-the-money.
• Since IV is an annualized statistic, we must use a conversion factor to generate an IV specific for the option contract in question.
• The BCI Expected Price Movement Calculator has such a conversion factor inherent ion the spreadsheet.

Real-life example with Futu Holdings Limited (Nasdaq: FUTU): Put option-chain on 10/4/2023

• 10/4/2023: FUTU trading at \$54.80 (FUTU is an eligible security on our BCI Premium Stock Report on this date).
• The near-the-money (close to ATM) \$55.00 put strike shows an IV of 0.50 (50%- yellow cell on the right).
• Using the BCI Expected Price Movement Calculator (see below), we determine the low-end of the trading range is approximately \$46.81.
• The \$47.00 put strike shows a bid price of \$0.56.

BCI Expected Price Movement Calculator Results

• This will be a 31-day trade, if taken through contract expiration.
• FUTU is expected to move up or down by no more than \$7.99, 84% of the time, during the contract.
• The low end of the range will lead us to the \$47.00 put strike (purple circle), which showed a bid price of \$0.56 in the 1st screenshot.

Initial calculations using the BCI Trade Management Calculator

• This is a 31-day trade, if taken through contract expiration (red circle).
• Initial time-value return is 1.21%, 14.20% annualized (brown cells).
• If exercised (expires in-the-money with no exit strategy implementation), shares will be purchased at a 15.26% discount from the price at trade entry (pink cell).

Discussion

In bear and volatile market conditions, we can utilize IV and the BCI Expected Price Movement Calculator, along with the BCI Trade Management Calculator, to establish our defensive trades that will frequently still results in significant annualized returns.

Exit Strategies for Covered Call Writing and Selling Cash-Secured Puts

This book contains 27 chapters of exit strategy information associated with covered call writing and selling cash-secured puts. My goal when writing this book was to create the most extensive publication ever published on position management for these strategies.

Over the years, the BCI community has been incredibly gracious by sending our BCI team email 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,

Thank you so much for your thoughtful responses.

You’ve inspired my husband and I so much. And we really appreciate how much you go the extra mile with responding to emails.

Have a wonderful week!

Cheryl

Upcoming events

1. Orlando Money Show Live Event

45-minute workshop: Monday October 30th 2:10 PM ET – 2:55 PM ET

Selling Cash-Secured Puts and Strategy Choices After Exercise

2-hour MoneyMasters Class: Tuesday October 31st 9:30 AM ET – 11:30 AM ET

How to Master Covered Call Writing:

A detailed start-to-finish analysis using real-life examples.

Details & Registration information here.

2. BCI-only webinar (all invited to our 500 Zoom maximum)

Thursday November 9, 2023

8 PM ET – 9:30 PM ET

Zoom link will be sent to all on our mailing list as event approaches.

Join our mailing list on the blog link of this site- right side scroll down.

Selling Cash-Secured Puts: Multiple Applications

Selling cash-secured puts is a low-risk option strategy geared to generating cash-flow, but always with capital preservation in mind.

This presentation will detail the strategy, incorporating the 3-required skillsets necessary to achieve the highest levels of returns … stock selection, option selection and position management.

If we allow exercise of the put options, shares are put to us at a price we agreed upon. What is our next step? This seminar will discuss potential paths we can take and the rationale behind these decisions, using real-life examples and calculations.

Q&A will include covered call writing, cash-secured puts and related strategies.

Zoom link will be sent to all on our mailing list as event approaches.

3. AAII Orange County, California Chapter

AAII Investment Club members only

Saturday November 11, 2023

Details to follow.

4. Long Island Stock Traders Meetup Group

Thursday February 15, 2024

7:30 PM ET – 9:00 PM ET.

Details to follow.

13 Responses to “How to Establish a Bear Market Cash-Secured Put Trade”

1. Dave October 21, 2023 2:48 am #

Alan,

Thanks for all of your content. I’m currently a premium member.

I have a pragmatic question regarding the 10% rule in the last week of a contract.

Given that any OTM contract will only have time value remaining, and given that the time value will likely go below the 10% threshold during the last days or hours of the contract, then the 10% rule will always take us out of the trade toward the waning days/hours of the contract.

It’s not a huge amount of value left but wouldn’t we better to adjust those 10% limit orders toward the end of the contract to collect that final 10%?

Dave

• Alan Ellman October 21, 2023 11:49 am #

Dave,

The 20%/10% guidelines are specifically titled “guidelines” to allow the user to veer slightly from the stated thresholds.

In the case of the 10% guideline in the last week of a monthly contract or for any weekly contract, we can move that % down or remove altogether, as expiration approaches, IF we can meticulously monitor our trades each day. For most of us, leaving the 10% (or less) guideline in place, frees us up to partially automate the exit strategy process as it relates to share price decline.

If the BTC limit order threshold is reached, the short call is closed, but shares are still retained, so we are not completely out of the trade.

Here is a link to an article I published, where the 10% guideline allowed me to “hit a double” in the last day of a contract:

https://www.thebluecollarinvestor.com/hitting-a-double-on-the-last-day-of-a-contract/

Alan

2. Andreas October 21, 2023 5:02 am #

Dear Allan,

As a premium member of BCI, I would like to ask you for your advice for a trade that went significantly against me :

On March 15, 2023 I bought 200 Shares of SCHW at 80 USD as a result of an assignment of a DITM Short Put with a Put strike at 80 USD.

This trade was the result of short put series on SCHW which I initially started back in November 2022, where I collected some nice premiums until end of Feb 2023.

At that time SCHW tanked as a result of the bank turmoils. I rolled the DITM put out in time and further down (but still DITM) for a positive net credit. But in March I got assigned 200 shares since the 2 puts were so deep in the money that there was too little extrinsic value left (even at 30 DTE !) so that the option was exercised.

Now the stock is trading at around 51 USD, resulting in a significant unrealized loss of -5.800 USD considering the original put strike as the cost basis.

Since March I am trying to continuously write covered calls on these 200 stocks in order to further reduce my cost basis. With that I could reduce my cost basis down to 74, but still significantly above the current market price.

Initially I decided to choose the 80 USD call strikes in order not to get assigned below my cost basis, but since the stock continued to significantly declined, there was not much premium left on the 80 call strike, so I decided to write calls below my cost basis.

I don´t really feel comfortable with this procedure since I might have to realize a significant loss in the stock once the stock starts a rally and the short calls would be in the money and either needed to be closed out at a loss or get assigned below my costs basis of the stock.

Another problem is, that this position now binds a lot of capital in my account which I could/would like to use more efficiently e.g. by collecting more option premiums in another underlying.

However, realizing a loss in the stock position is no option for me since this will wipe out more than one year of collected premiums. I also believe that SCHW is a good company and that the stock will trade at 80 USD again somewhere in the future.

Do you see an alternative to get myself out of trouble with this position? I also used your stock repair calculator but realized, that the 2 contracts of OTM Short calls (at a breakeven price) would not give enough premium to fully cover the cost for the purchased NTM call option. Using a OTM short call strike which is closer to the market prices is better in terms of cost coverage of the long call, however would also cap the upside below the breakeven point in case the stock starts to rally.

Now in hindsight I could say that if I would have followed the BCI rule with capping loss of a short put when the stock is trading 3% below the strike of the short put then I would not be in such a position. But now I have to somehow cope with the situation.

I would appreciate any advice that you can give to me how to get myself out of this unfavorable situation. Please also let me know your thought on writing covered calls below the cost basis of the stock (with which I feel somehow uncomfortable).

I very much appreciate your thoughts and advice.

Thanks and best regards,

Andreas

• Alan Ellman October 21, 2023 5:34 pm #

Andreas,

There are 3 aspects to your inquiry that should be addressed by all of us who have experienced losing trades, which is all of us.

First, how did I manage this series of trades?

Second, could I have done anything differently that would have mitigated the losses?

Third, what should I do now?

Before we get to these, allow me to be a bit philosophical in 2 regards:

1. Even trades that incur significant losses, can be amazing positives for us. This is because as we dissect the trades, and learn from them, we are in a position to improve our trading protocol, not only for the next trade, but for all similar scenarios for years and decades to come. It is an opportunity we must take advantage of.

2. Should we jump through hoops to mitigate losses on a specific stock/option position? That is our kneejerk reaction, but should we? Do we care about SCHW? NO!!! Do we care about the cash tied up in the position? YES!!! If that is the conclusion we come to, then we must ask ourselves this question: Where should I place the cash currently in this losing position, in SCHW or in a better-performing security? When SCHW was purchased, \$16,000.00 was paid. We now have \$10,200.00 worth of SCHW … where should we place that \$10,200.00?

Okay, let’s get to the 3 questions:

1. How was the trade managed? You answered this one yourself. Adhering to the BCI 3% guideline as it relates to selling OTM cash-secured puts would have eliminated almost all the pain.

2. Could I have done anything differently? See #1.

3. What should I do now? I can’t give specific financial advice in this venue, but I can make some generalizations you should find useful:

If you are bullish on the stock moving forward, write OTM (as it relates to current market value) covered calls to generate premium income and allow for share appreciation. Be prepared with our exit strategy arsenal (rolling options) if share price is expiring ITM.

If you feel that the cash currently in SCHW is better placed in a different security, sell the shares and analyze for a replacement stock.

Bottom line: Nobody likes to lose on a trade, but if we learn from them, it will put much more cash in our pockets over the long run. I suspect this will be the case with you and SCHW.

Sometimes, as they say, a picture is worth 1000 words. See the screenshot I created for the timeframe in question (Broken green arrow). No need for additional commentary except to say that there are better days ahead.

CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.

Alan

• Jorge October 22, 2023 7:11 am #

Alan and Andreas,

I have used the 3% guideline several times and it has bailed me out of losing trades in most cases. It’s a valuable tool.

Jorge

3. Barry B October 21, 2023 10:09 pm #

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 10/20/23.

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:

Reminder: Premium Member’s pricing is locked 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

4. Barry R October 22, 2023 1:15 am #

Hello Alan.

If I sell 2 week options what is the timing for 20/10% management?

Thank You.

Barry R

• Alan Ellman October 22, 2023 6:50 am #

Barry,

Selling a 2-week option is precisely the same as our management in the final 2 weeks of a monthly contract … the 10% guideline applies.

Alan

5. Audrey October 22, 2023 3:05 pm #

Alan,

Good afternoon 😊

What is the recommendation when the list of stocks that have passed the screens (and aren’t reporting earnings before expiry date) is very small (4 stocks this week)?

Do you sit on cash till after some report earnings? Look at the stocks that passed previous weeks and failed the current week?

I’m selling off my holdings that report this coming cycle, as I’ve learned my lesson on holding stocks through earnings, but I’m not sure where to redeploy, or if I should stay in cash.

I like this week’s blog post on the puts, but again the list is small, and I wouldn’t want to overweight on any of these stocks.

Thank you!
Audrey

6. Alan Ellman October 23, 2023 7:01 am #

Audrey,

Earnings season is always challenging and this one is no exception, but we do have answers.

We do see that the number of eligible securities is down this week because of the bearish week last week hurting our technical requirements. Let’s hope that next week’s report is more robust.

Now, for solutions. Here are some ideas:

1. Note the 1st 6 securities report this week,and will be eligible for the last 3 weeks + of the November contracts.

2. All securities reporting this month that have weekly options (in next week’s report) can be used, just avoiding the week of the ER.

3. ***All eligible exchange-traded funds in our ETF report are eligible since ETFs do not have earnings reports.

4. The current Blue Chip (Dow 30) Report can be implemented. All have weekly options and we can circumvent the week of earnings.

5. If the securities available that meet your trading style, will not allow for appropriate diversification based on the cash available, you can remain in partial cash and re-evaluate the watch lists that will be published this week.

Earnings season challenges may not have great solutions, but they all have best solutions.

Alan

7. Audrey October 24, 2023 9:12 pm #

Alan,

Do you recommend keeping the weekly options in a separate spreadsheet than monthly ones? (using the TMC). I’m probably overthinking it. 😉

Thanks,
Audrey

• Alan Ellman October 25, 2023 6:13 am #

Audrey,

You’re bringing out an excellent consideration.

There is a myriad of ways to manage our TMC spreadsheets. Here’s how I set things up:

Since I have multiple option-selling portfolios (weeklys and monthlys, calls and puts), I set up a dedicated spreadsheet for each contract expiration.

For example, for the monthly 11/17/2023 expirations, I “save as” a TMC spreadsheet TMC_11-17-2023.

For next week’s weekly expirations: TMC_11-3-2023.

I find that by managing this way, all trades on each spreadsheet have the same contract expiration date.

I always have 1 spreadsheet saved as “TMC_BLANK” and name the others off this master.

Alan

8. Alan Ellman October 25, 2023 4:52 pm #

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.