When we sell cash-secured puts, we must use all 3 of our required skills: stock (or ETF) selection, option selection and position management. Once we have selected an elite-performing security, we then choose an out-of-the-money (OTM) put strike that meets our initial time-value return goal range (2% – 4% per-month, for me). Without exit strategies, our maximum return is the put premium and that profit is realized as long as share price does not decline below the OTM put strike. But what do we do if share value does decline below that put strike despite our rigorous screening process? Enter our 3% guideline for selling cash-secured puts.
What is the 3% guideline?
This guideline gives us a parameter that assists us in determining when to close our short put position should share value decline significantly. When share value drops more than 3% below the OTM put strike, we should consider closing the short put position. Most of the time, this will result in a trade loss. The cash used to secure that original put trade can then be used to initiate a new put sale, in the same contract cycle, with a different underlying to recover some or all of those losses.
Real-life example with NVDA
- 8/20/2021: NVDA trading at $208.16
- 8/20/2021: STO the 9/24/2021 $200.00 put at $5.65
- What is the trade status if NVDA drops 3% below the $200.00 strike to $194.00, a decline of $14.16 per-share?
BCI Elite Put-Selling Calculator
NVDA Put Calculations with 3% Guideline
What is our loss if NVDA drops below the $194.00 3% guideline price point?
Is it $0.35 per-share ($194.35 BE – $194.00 put strike)?
If the shares are put to us at the put strike of $200.00 and NVDA is trading at $194.00, we are losing $0.35 per-share.
Is it greater than $0.35 per-share?
If we are forced to close the short put due to breach of the 3% threshold, we will be losing more than $0.35 per-share. This is because we have to spend money to close the short put (buy-to-close or BTC). That loss will be represented by the following formula:
[$5.95 – (cost-to-close the short put)]
There are 2 Greek factors at work that will determine the CTC the short put:
- Delta: Share decline increases the value of the put making it more expensive to buy back
- Theta: As time progresses, the time-value erosion effect of Theta will cause put value to decline
Overall, we should expect the CTC to be greater than the initial put premium resulting in a trade loss.
Discussion
The 3% guideline is used to mitigate losses and potential greater losses. In the case of NVDA, if share price drops from $208.16 to $194.00 (3% guideline), we have a problem and must take action. The spreadsheet shows the BE price point to be $194.35 resulting in a loss of $0.35 per-share if shares are “put” to us at $194.00. This represents the (put strike – put premium). This stat does not include any exit strategy executions. If we bought back the put option as share price declined, the loss would be ($5.65 – cost-to-close the $200.00 put). This would result in a loss greater than $0.35 per-share but would also mitigate additional losses on a security that has declined in value substantially in this hypothetical. Not all trades will be winners. Our job, as CEOs of our own money, is to mitigate losses and enhance gains.
For more information on selling cash-secured puts
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Market tone data is now located on page 1 of our premium member stock reports and page 1 of our mid-week ETF reports.
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Alan,
If a stock has weekly options and is reporting earnings late in a monthly contract, do you favor weekly options or writing a 2 month option?
Thank you,
Elliot
Elliot,
If a stock or ETF has associated weekly options, I prefer this approach. It will result in higher annualized returns and allow for more frequent re-evaluations of our bullish assumptions on the underlying security.
If the stock or ETF does not have weekly options, we go to plan B… the 2-month option keeping an eye on earnings report dates.
Alan
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 12/17/21.
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:
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On the front page of the Weekly Stock Report, we now display the Top Performing ETFs, the Top SPDR Sector Funds, and the 4 single Inverse Index Funds. They are sorted using the 1-month performances from the Wednesday night ETF report and the prices from the weekend close.
Please make sure that you review the new feature that we’ve added…Implied Volatility or IV. This is the At The Money (ATM) Implied Volatility for all of the stocks in the report.
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Hallo Alan and Barry,
sometimes we have shares and options in our portfolio which recently had been removed from the white/yellow list and are then on the pink list.
How would you suggest to handle them ? Selling, ….. ?
Perhaps there is a description or video about that, but I’m not aware of any.
Best regards,
Reiner
Hi Reiner,
If the stock is currently used in an option trade, we manage that trade as set forth in our exit strategy arsenal, not based on its removal from the white cells in our report.
If the contract expired with the strike out-of-the-money and we retained the shares, we may still decide to retain that security for the next contract cycle as long as the technical analysis is mixed rather than all bearish. That information is in the report.
Please see screenshot below:
In the most recent report, I would consider retaining AAPL, CCS, CUBI and DHI and would sell ATKR and CTRA.
One important question we ask ourselves is: Would we buy this stock today at the current price?
We give our stocks 3 weeks to recover and become eligible before removal from the pink cells.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan
Hi Alan,
Is there any change to the 3% guideline strategy when we sell cash secured puts on QQQ or SPY instead of single stocks?
Thank you.
Marcelo,
3% is a solid, reliable guideline as when to close the short put. It is based on a drop >3% below the out-of-the-money put strike.
The research I did on this topic was based on monthly put trades where I was seeking an initial time-value return goal range of 2% – 4%.
Frequently, with ETFs, the returns will be slightly lower so that threshold can be a bit less. This is why I allude to this exit strategy as a “guideline” To keep it simple, I stay with 3% for all my put trades and that is the stat we use in our calculators.
Alan
Thank you Alan.
Alan,
When you say once the premium declines to 20% of the original premium. What are we comparing that to. The bid or ask price. For example. If the 20% is $0.30 is it the bid or ask price that has to get to the $0.30?
Tom
Tom,
Let’s set up a hypothetical example:
If we sold the covered call for $2.00 (per-share) for a monthly contract, we immediately set-up a buy-to-close (BTC) limit order to close the short call at $0.40 which is 20% of $2.00. We change that BTC limit order to $020 (10% of $2.00) with 2 weeks remaining until expiration.
These thresholds are for the “ask” price or a negotiated price. I specifically referred to these as “guidelines” which gives us some flexibility to close the short calls if the price is “near” those thresholds.
Alan
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