Strategies for selling cash secured PUT options inside a retirement account

[Red Lion]

I've dabbled with writing put options over the last decade, and I currently write out of the money LEAP puts in my taxable account on margin to scalp some extra premiums while I wait to add to my otherwise fully invested (taxable) account. These aren't a huge impact to the taxable portfolio because I like to keep my maximum margin exposure if I'm assigned on options to under 20% of the portfolio weight (right now it's sitting around 15% if all were assigned). I've always avoided shorter durations because I'm trying to avoid generating short term trading profits for overall tax management. 

 

I recently setup a 401k for my small business where I'm finally able to max out the employer profit sharing and employee contributions and trade my individual account through a Schwab brokerage account. I just funded the $19,500 employee contribution for 2021 in full, and should be able to put in another $61,000 by early 2022 after doing employer contributions and front-running 2022 employee contribution. I'm awaiting approval on level 0 (the highest allowed for this type of 401k account) options privileges which would allow cash secured puts and covered calls. 

 

With the preamble out of the way, I would like to hone my strategy on writing cash secured PUTS in a tax deferred account, which is going to look a lot different than the OTM LEAP puts that I've traditionally written in a margin account.  I will be writing options on shares that I want to acquire for the long term, but would like to: 1) earn an attractive rate of return on these positions in the event I'm not assigned the shares; and 2) get a good entry point on the shares. 

 

I'll use APO as an example, I already own shares acquired in the $30s, I'm short January 23 LEAP PUTS @ $65 in my margin account, I would like to add to my position so I'm evaluating short term cash secured puts that I could sell to earn attractive returns or an attractive entry point. I'm bullish on the underlying shares, and absent a market crash, I expect them to trade to $100 within the next 12 months. I don't want to miss out on the upside, so I want to be relatively aggressive on strategy to keep more upside if the shares continue to rally. So I see a few possibilities, and wanted to run them by the experts to see if I can gain some new perspectives. 

 

APO closed today at $76.29

 

Option 1: 

 

12/10/21 $76 PUT - BID - $2.65 at market close, 

Price to acquire shares if PUT to me - $73.35

Total return if PUT expires worthless - 3.6%

Annualized IRR if put expires worthless - 42.5% 

 

Option 2: 

 

3/18/22 $75 PUT - BID - $5.50 at market close, 

Price to acquire shares if PUT to me - $69.50

Total return if PUT expires worthless - 7.92%

Annualized IRR if put expires worthless - 22.4%

 

Option 3: 

 

6/17/22 $75 PUT - BID - $7.40 at market close, 

Price to acquire shares if PUT to me - $67.60

Total return if PUT expires worthless - 10.95%

Annualized IRR if put expires worthless - 17.9%

 

Option 4: 

 

03/18/2022 $80 PUT - BID - $8.30 at market close, 

Price to acquire shares if PUT to me - $71.70

Total return if PUT expires worthless - 11.58%

Annualized IRR if put expires worthless - 32.76%

 

Option 5: 

 

6/17/22 $80 PUT - BID - $10.10 at market close, 

Price to acquire shares if PUT to me - $69.90

Total return if PUT expires worthless - 14.45%

Annualized IRR if put expires worthless - 23.97% 

 

Option 1 has a great annualized IRR, but it has two big negatives which is that: 1) if I get assigned the shares I pay the highest price; and 2) if the stock rallies hard over a short period of time I only stand to make a 3.6% total return. 

 

Option 2 may be a good choice, it gives me a mid level entry point, >20% IRR if it expires worthless, this still limits my total return to 7.92% if the stock continues to rally up to my price target of $100

 

Option 3 gives the lowest entry point if the stock tanks, but also gives the lowest IRR of all 5 choices, I feel that this is probably the most conservative choice . 

 

Option 4 is currently sticking out as the most attractive to me, would love to hear other's input...This is not the lowest entry point if assigned (but still better than the 30 day options), I can make 11.58% total return if the stock ends above $80 in the next 4 months, and my IRR is 32.76% which seems quite attractive for cash secured PUTS

 

Option 5, similar to option 4, but you trade the more attractive potential entry point in the shares for a higher IRR. 

 

 

I'm considering selling shorter term in the money options, option 4 or something like that, so I can earn good IRR / buy the stock at a discount. Is this how you cash secured PUT experts would analyze this situation? What would you do?

[boilermaker75]

I've done things similar to all your scenarios. I have kind of gravitated to shorter term puts, sometimes writing them the same week they expire right up to expiration. I like getting the play over with, especially if there are potential margin considerations. Plus as you point out the incremental increase in time premium decreases as you increase the time to expiration.

 

As long as you pick a strike price that is at a good valuation you will do ok. It just limits your profit if the stock takes off. I now do 75% of my put writing on BRKB. BRKB is also my largest position, by far, so if it takes off I am happy! Although I wish it stays here for years so Buffett can buy a lot of it back.

[Red Lion]

3 hours ago, boilermaker75 said:

I've done things similar to all your scenarios. I have kind of gravitated to shorter term puts, sometimes writing them the same week they expire right up to expiration. I like getting the play over with, especially if there are potential margin considerations. Plus as you point out the incremental increase in time premium decreases as you increase the time to expiration.

 

As long as you pick a strike price that is at a good valuation you will do ok. It just limits your profit if the stock takes off. I now do 75% of my put writing on BRKB. BRKB is also my largest position, by far, so if it takes off I am happy! Although I wish it stays here for years so Buffett can buy a lot of it back.

 

I would like to write PUT options on BRK.B, unfortunately, I will need to wait until early next year until I can contribute enough to this account to do so.

 

Do you write slightly OTM options, or risk it up a bit with ITM? 

[boilermaker75]

1 hour ago, RedLion said:

 

I would like to write PUT options on BRK.B, unfortunately, I will need to wait until early next year until I can contribute enough to this account to do so.

 

Do you write slightly OTM options, or risk it up a bit with ITM? 

I write OTM options. The closer to expiration the closer the strike price to the current price.

 

Today I wrote Nov 19 280-strike BRKB puts. I am currently short Nov 12 280-strike BRKB puts. As some are getting close to expiration I'll write some more.

[IceCreamMan]

On 11/9/2021 at 5:34 PM, RedLion said:

I would like to hone my strategy on writing cash secured PUTS

 

When you sell a put, you could be making two bets:

1) the stock will go up

2) the stock has a narrower distribution of future outcomes than the options market is pricing (i.e. the stock will not move much)

 

It may be helpful to think about these two bets separately. To the extent that you want to bet on the first one, you may want to sell ITM puts. To the extent that you want to bet on the second one, you may want to sell ATM or OTM puts.

 

If you want to bet on the second one: To what time frame does your belief apply? This can inform your choice of expiration date. For example, if you think APO will have relatively low volatility over one month periods, you might sell 1-month ATM puts.

[IceCreamMan]

I guess choosing a strike price is like choosing where you want to be in the capital structure. Looking at the extremes, if you choose a deep ITM put to sell, your return profile is almost identical to an equity investor's. If you choose a deep OTM put to sell, you're similar to a credit investor (your upside is fixed, your maximum loss is a large multiple of your upside, but your probability of gain is very high).

[Pelagic]

For cash secured puts, I'm partial to a shorter duration - 30 days or less, sometimes weeklies even if possible. Basically Boilermaker's strategy posted above that he does with BRK.

[rkbabang]

27 minutes ago, Pelagic said:

For cash secured puts, I'm partial to a shorter duration - 30 days or less, sometimes weeklies even if possible. Basically Boilermaker's strategy posted above that he does with BRK.

 

 

I do this often.  Sometimes to act as a limit order, I write the put for the strike that I want to buy the stock at and usually it goes unfilled and I just keep the premium.  Other times I do it expecting not to be put too.  I've been making ~$1000/month lately writing puts 1 month out on WMB (The $28 puts I wrote a month ago are expiring tomorrow).  With energy inflation as it is I don't think it will go down, so it is like printing money.  And if I'm put to, I'd be perfectly happy to own it at $28. 

 

[IceCreamMan]

12 hours ago, rkbabang said:

if I'm put to, I'd be perfectly happy to own it at $28. 

 

Here's how I usually look at it:

 

On the expiration date, regardless of the stock price and regardless of whether or not I previously sold an option on it, I have the ability to own the stock. That's not dependent on whether or not I previously sold a put. If the stock falls below the strike price, the only economic difference in the case that I sold a put is that I now have a loss.

 

Whether I cover my put a moment prior to expiration or not... whether I keep the shares from an automatic exercise or sell them immediately... doesn't actually impact the bet that I already lost.

[boilermaker75]

7 hours ago, IceCreamMan said:

 

Here's how I usually look at it:

 

On the expiration date, regardless of the stock price and regardless of whether or not I previously sold an option on it, I have the ability to own the stock. That's not dependent on whether or not I previously sold a put. If the stock falls below the strike price, the only economic difference in the case that I sold a put is that I now have a loss.

 

Whether I cover my put a moment prior to expiration or not... whether I keep the shares from an automatic exercise or sell them immediately... doesn't actually impact the bet that I already lost.

 

 

 

Same as if you put a limit order in to buy at $28, except you didn't pocket the put premium. You sill have a loss if the stock trades below $28, actually a larger loss by the amount of the put premium. Have you ever bought a stock that didn't ever trade below the price you purchased it at?

[Red Lion]

Thank you all for some great input. For the particular stock I posted about, I have added a fair amount of actual stock that I plan to hold long term over the last few days. This lets me feel comfortable about sticking to the much shorter term options with higher IRR, if APO rallies I've got enough that I'll be happy either way. 

[IceCreamMan]

13 hours ago, boilermaker75 said:

Same as if you put a limit order in to buy at $28, except you didn't pocket the put premium.

 

If the stock falls to $28 and then rises, my limit order gives me all of that upside. Not so for selling a put.

[boilermaker75]

22 hours ago, IceCreamMan said:

 

If the stock falls to $28 and then rises, my limit order gives me all of that upside. Not so for selling a put.

 

If the stock falls to $28.01 I make money and you don't make anything, We can play this game all night.

[IceCreamMan]

23 hours ago, boilermaker75 said:

 

If the stock falls to $28.01 I make money and you don't make anything, We can play this game all night.

 

I was just pointing out how it is not the same as putting in a limit order.

[Gregmal]

When selling puts you aren’t really looking to be an investor, just a dealer at the casino who takes his cut regardless, with the worst case scenario being you have to make an investment of your choice at a price and time of your choice. I like that gig. 

[boilermaker75]

1 hour ago, IceCreamMan said:

 

I was just pointing out how it is not the same as putting in a limit order.

 

I know, sorry I was flippant in my response.

[boilermaker75]

I write anywhere from 20-50 put positions each month. It is not 20-50 different stocks, but different strike prices and expiration dates. In November, so far, I have written 20 put positions on BRKB, WFC, BAC, FB, and MSGE.

 

Most months they all expire OTM. That would not happen doing this with 5 random stocks.

 

When some are ITM near expiration I can buy them back. Sometimes still for a gain if they are near the money. If not, I will sometimes buy them back for a loss and write a put at the same strike price at a later expiration date that would eventually result in a gain. This has always worked with BRKB ever since the B shares started trading.

 

Sometimes I keep the stock. That is when I think of writing a put as a limit order. All my current positions I entered by being put to. I have some BRKB, WFC, and BAC that I have had for around 12 years. It is rare to not be able to acquire a stock by writing an OTM put. This gives me a discipline to wait for my price. The only stock I recall not acquiring, which I wanted, was MCD at a strike price of $90 when MCD was trading in the $90s.

[maxthetrade]

Last week I had written $116 covered calls on DLTR. The stock closed ~$113 on Friday but about half of the options were execercised despite beeing way out of the money. Why would someone excercise these options? Even if you knew about the Mantle Ridge news it would have been much cheaper to buy the stock.  

[Gregmal]

11 minutes ago, maxthetrade said:

Last week I had written $116 covered calls on DLTR. The stock closed ~$113 on Friday but about half of the options were execercised despite beeing way out of the money. Why would someone excercise these options? Even if you knew about the Mantle Ridge news it would have been much cheaper to buy the stock.  

I dont know why this is but I have learned over time not to trust this kind of stuff. If something is close and the premium is basically gone, I just close it out. Too many times Ive heard of stuff like this, where you have a $100 put sold and the stock closes Friday at 101....and then you get exercised as the stock is opening Monday at $98.....I just pay the couple bucks so I dont have to worry about getting screwed. 

[aws]

1 hour ago, maxthetrade said:

Last week I had written $116 covered calls on DLTR. The stock closed ~$113 on Friday but about half of the options were execercised despite beeing way out of the money. Why would someone excercise these options? Even if you knew about the Mantle Ridge news it would have been much cheaper to buy the stock.  

You get until 5:30pm to exercise options expiring that day. The stock traded above $116 right after the close, so those who held options could exercise and then sell the stock for a small profit. Some brokers set the deadline earlier though, and I don't think automatic exercises take into account after hours activity, so that's probably why only some of yours were assigned. The rest weren't paying attention or were locked out by their broker.

Edited November 15, 2021 by aws

[maxthetrade]

1 hour ago, aws said:

You get until 5:30pm to exercise options expiring that day. The stock traded above $116 right after the close, so those who held options could exercise and then sell the stock for a small profit.

 

That makes sense, thanks for the explanation.

[Red Lion]

5 hours ago, boilermaker75 said:

 

I write anywhere from 20-50 put positions each month. It is not 20-50 different stocks, but different strike prices and expiration dates. In November, so far, I have written 20 put positions on BRKB, WFC, BAC, FB, and MSGE.

 

Most months they all expire OTM. That would not happen doing this with 5 random stocks.

 

When some are ITM near expiration I can buy them back. Sometimes still for a gain if they are near the money. If not, I will sometimes buy them back for a loss and write a put at the same strike price at a later expiration date that would eventually result in a gain. This has always worked with BRKB ever since the B shares started trading.

 

Sometimes I keep the stock. That is when I think of writing a put as a limit order. All my current positions I entered by being put to. I have some BRKB, WFC, and BAC that I have had for around 12 years. It is rare to not be able to acquire a stock by writing an OTM put. This gives me a discipline to wait for my price. The only stock I recall not acquiring, which I wanted, was MCD at a strike price of $90 when MCD was trading in the $90s.

 

Are you writing all of these on a cash secured basis? I'm looking at opportunities in APO, FISV, FB, MO, and ATVI. Other than APO, I'm looking to add a lot more of these common stocks over the next year or two, so they seem like good opportunities. 

[boilermaker75]

About half are in accounts that would put me on margin. That is why I like to use short-term puts and if ITM I will BTC and STO same strike but further out in time rather than get put to and sell covered calls where I would have to pay margin interest. 

 

I would probably be 10% on margin if I were put to on everything. But I suspect that is a once every 10 year event and I can always cover it by mortgaging my house! House mortgage rates are way better than Schwab margin rates.

[Red Lion]

On 11/15/2021 at 1:27 PM, boilermaker75 said:

About half are in accounts that would put me on margin. That is why I like to use short-term puts and if ITM I will BTC and STO same strike but further out in time rather than get put to and sell covered calls where I would have to pay margin interest. 

 

I would probably be 10% on margin if I were put to on everything. But I suspect that is a once every 10 year event and I can always cover it by mortgaging my house! House mortgage rates are way better than Schwab margin rates.

 

I just sold a $63.50 November 17 option on ATVI for $0.40 which expires in 2 days. Just putting my toes in at this point, and selling these on margin, because there's still some sort of holdup on getting covered calls/cash secured puts approved in my 401k account. 

 

If all my outstanding puts were assigned, my Schwab margin account would be about 30% on margin which would definitely be out of my comfort range, however I've got a significant amount of securities that I can transfer over to my Schwab account from a Chase You invest account (I just keep this because it's easy to transfer money from my my chase accounts on the same day, and have used it to make spur of the moment purchase decisions on many occasions, then eventually transfer securities over to Schwab if needed for margin purposes). 

[boilermaker75]

3 hours ago, RedLion said:

 

I just sold a $63.50 November 17 option on ATVI for $0.40 which expires in 2 days. Just putting my toes in at this point, and selling these on margin, because there's still some sort of holdup on getting covered calls/cash secured puts approved in my 401k account. 

 

If all my outstanding puts were assigned, my Schwab margin account would be about 30% on margin which would definitely be out of my comfort range, however I've got a significant amount of securities that I can transfer over to my Schwab account from a Chase You invest account (I just keep this because it's easy to transfer money from my my chase accounts on the same day, and have used it to make spur of the moment purchase decisions on many occasions, then eventually transfer securities over to Schwab if needed for margin purposes). 

 

If they start heading ITM you can always buy them back so you don't have to go on margin. You could then either accept a small loss, or sell some Nov 26 puts. The Nov 26 puts could be at a lower strike and between the two plays you could still come out ahead.