beginners corner

Selling In-The-Money Cash-Secured Puts to Buy a Stock at a Discount

click ↑ 4 Featured

When we sell cash-secured puts, we have 2 possible outcomes. If unexercised, we generate cash flow or, if exercised, we buy the underlying security at a discount. This article will provide a blueprint as how to craft our put-selling trades, if we want to own the underlying stock or exchange-traded fund sooner rather than later, using in-the-money (ITM) put strikes.

Real-life example with DocuSign (Nasdaq: DOCU)

  • 12/26/2023: DOCU trading at $60.66
  • 12/26/2023: Sell 1 x 1/19/2024 (ITM) $62.00 put at $2.94
  • Pre-stated goals (as an example) is 2% – 4% for both initial time-value return and potential share purchase discount

DOCU option-chain on 12/26/2023

The ITM $62.00 strike displays a bid price of $2.94.

DOCU initial calculations using the BCI Trade Management Calculator (TMC)

  • The spreadsheet shows a 25-day trade, if taken through contract expiration (red circle)
  • The initial unexercised return is 4.98%, 72.68% annualized (brown cells)
  • If exercised (share price moves above the $62.00 strike), the purchase discount is 2.64% (pink cell)
  • Exercise is more likely when using ITM strikes compared to ATM and OTM strikes

Discussion

Selling cash-secured puts results in 1 of 2 outcomes. Either the trade will generate cash flow or shares will be purchased at the agreed upon sales price, at a discount from the original price when the trade was initially executed. ITM put strikes are more likely to be exercised, compared to ATM and OTM strikes.



Alan Ellman’s Complete Encyclopedia For Covered Call Writing Volume-2

Education is power. That’s the premise of the Blue Collar Investor. When the Complete Encyclopedia for Covered Call Writing was published at the end of 2011 and immediately became the best-selling book on this great strategy, I realized that eventually there would be a Volume 2. It took me four years to gather the information for the original version and I projected four years down the road and realized that more information would become available, more examples could be provided to clarify certain issues and BCI members would make me aware of tangential topics of interest. I also write weekly newsletter articles for the BCI site as well as for other US and international financial venues. It didn’t take a stroke of genius to craft a plan that would allow me to provide new and enhanced information and keep it within the framework of the Complete Encyclopedia for Covered Call Writing, a format you have embraced more than I could ever have imagined. Volume 1 (classic edition) should be read first.

Click here for more information and purchase option.


Your generous testimonials

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:

Good afternoon, Alan, 

I am not new to trading options, but I can definitely use some help. I absolutely love the service BCI provides. The volume of free material that you provide is in itself a gold mine. I am reading and re-reading many of the articles. In fact, I am so impressed that I have already purchased the CEO Package.

Best regards,

Edmund

Upcoming events

1. Mad Hedge Stock Investor Summit (online event)

June 2024

Information to follow.

2. BCI-Only Webinar (Zoom)

July 2024

Details to follow.

3. Investment Masters Symposium

August 1, 2024

8:45 AM – 10:45 AM

Paris Hotel, Las Vegas

Covered Call Writing & Selling Cash-Secured Puts to Generate Consistent Cash Flow

Basic & advanced principles for trading low-risk stock options with capital preservation in mind

This presentation will detail stock selection, option selection and position management, the 3-required skills to become elite covered call writers and put-sellers. It will also include ultra-conservative approaches to these strategies using Delta and implied volatility to create statistically beneficial trades. Rules and guidelines will be discussed to take the emotions out of our trades resulting in high-probability positive outcomes.

Detailed analysis will be provided regarding how to craft our trades to the current market environment, personal risk-tolerance and strategy return goals.

A multi-tiered option-selling strategy which combines both covered call writing and selling cash-secured puts will also be examined. It is known as the PCP (put-call-put) or “wheel strategy.”

Attendees will be introduced to a one-of-a-kind trade management tool, the Trade Management Calculator, which is used to enter, manage and generate final realized and unrealized trade results.

The course is structured to benefit both beginner and advanced option traders, using real-life examples to enhance the learning process.

Registration details to follow.

4. Stock Traders Expo- live event in Orlando Florida

October 17 -20

Details to follow.

Alan speaking at a Money Show event********************************************************************************************************************

Begin additional segments text here (like testimonials, events, etc.)

17 Responses to “Selling In-The-Money Cash-Secured Puts to Buy a Stock at a Discount”

  1. George April 27, 2024 3:43 am #

    Hi Alan:

    You’ve mentioned that QQQ is one of your favorite tickers to use for covered calls. I’ve recently started trading weekly covered calls on it.

    I was wondering if you avoid placing trades on high volatility weeks (Fed meetings, CPI announcements, etc.) or just sell deep in the money calls.

    Thanks.

    George

  2. Alan Ellman April 27, 2024 6:20 am #

    George,

    My response applies to all securities, not just QQQ.

    I am almost always fully invested, even during the events you mentioned. I did move to partial or all cash during the financial crash of 2008, pre-Brexit and prior to the last 2 presidential elections. Those were aberrations.

    The “moneyness” of my strikes are dictated by my overall market assessment and personal risk-tolerance.

    We can also “ladder” our strikes. For example, if we are selling 5 contracts for 1 particular security, and we are defensive on our market outlook, we can sell 3 ITM and 2 OTM, or 4 and 1.

    Finally, QQQ. Yes, this has been the underlying security I have used the most over the past few decades. However, there are times with large-cap technology is out-of-favor with institutional investors and QQQ may not be present in any of my option portfolios.

    Alan

    • George April 27, 2024 11:26 am #

      Thanks for the excellent response

  3. Barry B April 27, 2024 11:36 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 04/26/24.

    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 Member’s pricing is locked into your current rate and will never see a rate increase as long as the membership remains active.

    Barry and The Blue Collar Investor Team

  4. Alan Ellman April 28, 2024 9:47 am #

    Weekly options:

    Premium members,

    I am re-enforcing the fact that, although many of the securities listed from last night’s premium stock report, are not eligible for the May 17 contracts due to earnings reports, but some are available for weekly trades.

    There are currently 5 stocks in that report which are not eligible for monthly May 17 expirations, but are eligible for weekly trades, except the week of the earnings report.

    Alan

  5. Elliot April 28, 2024 12:25 pm #

    Alan,

    I recently listened to another expert discuss ( and recommend) writing covered calls around an earnings report because the premiums are much higher.

    I’ve heard you state many times that you avoid earnings reports.

    Couldn’t you both be correct?

    Thanks,
    Elliot

    • Alan Ellman April 29, 2024 6:21 am #

      Elliot,

      I never comment on other option experts, but I’m happy to explain my position on earnings reports.

      Covered call writing and selling cash-secured puts are low-risk option-selling strategies, with capital preservation as an essential goal.

      By incorporating earnings reports into the mix, we are converting these investment approaches to higher-risk strategies, with potential for higher returns, but also, greater losses, if the reports disappoint.

      We can easily generate initial time-value returns of between 1% – 4% per-month using stock and ETFs and avoiding earnings reports. This, in my humble opinion, will satisfy most retail investors, and even professionals who are investing money for their clients.

      Alan

    • Bob April 29, 2024 7:15 am #

      Elliot,

      I got hammered several times with bad earnings reports before I started following this rule. No more ER worries.

      Just my 2 cents.

      Bob

      • Barry B May 1, 2024 1:56 pm #

        Bob,

        I completely agree. A perfect example is SMCI. This stock had a great premium yesterday but was absolutely crushed today!

        Best,

        Barry

  6. Rick April 30, 2024 7:24 am #

    Alan,

    When do you check options chains when preparing your portfolios for the new contracts? I usually check on the Sunday before market opens.

    Thank you.

    Rick

    • Alan Ellman April 30, 2024 1:34 pm #

      Rick,

      Saturday or Sunday is fine for a preliminary assessment of potential option returns.

      We will get a precise evaluation after the market opens on Monday, when market-makers can evaluate order flow and then publish bid-ask spreads that we can work with.

      I, typically, execute my initial trades On Monday between the hours of 11 AM ET and 3 PM ET. This avoids early morning and late afternoon institutional computerized trading.

      Alan

  7. John April 30, 2024 10:50 am #

    Morning Alan,

    I’d like to know your opinion of something I’m puzzled about.

    As an example, LRN, VRT, BSX, and AEM all gapped up after earnings. I didn’t place trades on these yet. Sometimes after the spike, the price will fall , so I’m inclined to wait. AEM, for example, has dropped a few dollars per share, and so has BSX. So now I’m seeing the price fall I’m inclined to get in. VRT is still climbing.

    But. If I enter a trade at a price that’s gapped up, there is a real possibility to hit a double if the price falls, especially early in the cycle. How do you look at this dichotomy, please?

    Thank you,

    John

    • Alan Ellman May 1, 2024 8:36 am #

      John,

      After a post-earnings gap-up, we wait for the initial volatility (if any) to subside, and if the security still meets our system requirements (likely), we can enter the trade at that point in time.

      Entering a trade after the initial spike-up and not waiting for volatility to diminish is a bit risky, and why take that risk?

      “Hitting a double” is a wonderful exit strategy when share price declines. However, if we can avoid share price decline, even better.

      Alan

      • John May 1, 2024 9:40 am #

        Alan,

        Thanks for getting back to me.

        Yesterday I did enter VRT as there had been some slight reduction in price and of course right after that it dropped again 😄

        So your input is timely and well written. I think this is one of the weaknesses in my trading. Which is why I sent the question.

        Thanks for the much needed help.

        John

        PS
        I’m mostly able to make a profit but some months I don’t. My return over the last year is 21%.

  8. Alan Ellman May 1, 2024 4:53 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

  9. Stuart May 2, 2024 3:51 am #

    Alan,

    I recently used the 20% guideline for cash secured puts when stock price went way up.

    I used the cash to enter another put trade with a new stock.

    My question is how to properly use the capital adjustment section when this happens.

    Thanks,
    Stuart

    • Alan Ellman May 2, 2024 6:11 am #

      Stuart,

      Nice going using this exit strategy and initiating a 2nd income stream in the same contract cycle with the same (similar) cash investment.

      Now, for the capital adjustment section of the Trade Management Calculator (TMC):

      Let’s say the initial trade required $5k to secure the put trade, and the second trade required $6k.

      We go to the Capital Adjustment section of the TMC and enter a (-)5k with the corresponding ticker symbol. We deduct the lower of the 2 amounts.

      Using the capital adjustment section will provide accuracy for the total investment made for that specific contract cycle and allow for precise % return calculations.

      Alan

Leave a Reply

Optionally add an image (JPEG only)