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calculating returns for selling puts


scorpioncapital
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For deep out of the money puts, I take the return to be roughly equal to the premium divided by the collateral requirement. Some people take it as the risk of exercise * the cost divided by the premium (but how do you quantify the risk for an of the money option?).

 

as an aside, do people think getting 10.5% annualized on a 4month put that is 33% out of the money is a good deal in this environment?

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For deep out of the money puts, I take the return to be roughly equal to the premium divided by the collateral requirement. Some people take it as the risk of exercise * the cost divided by the premium (but how do you quantify the risk for an of the money option?).

 

as an aside, do people think getting 10.5% annualized on a 4month put that is 33% out of the money is a good deal in this environment?

 

I write puts, usually slightly out-of-the money, on stocks that I feel are well below IV. Historically I probably get put to approximately 5% of the time and those are positions I am glad to have. (I am close to 80% invested and all my positions are a result of being put to.) For what I am doing I don't worry about risk of exercise. So I calculate my return based on premium to the collateral required.

 

If the current underlying stock is below IV, I would like to know what put would give you 10.5% annual return with an additional 30% MOS.

 

 

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By collateral is how I used to calculate the returns.  I haven't done any for a year or so because of my job.

 

In response to the second question, if the stock at that lower price is something you want to own, the return looks good.  I had a friend who made a disaster of a trade about two years ago...FSLR puts at $90 strike with a month out had decent premiums so he went in and sold 2 of them...got put the stock and at that point it wasn't a disaster but he decided to sell calls on it "to make it back".  Anyways, that was his relocation package so he lost about 80% in a 3 month period and ended up in a not so pleasant part of Austin. 

 

The way I used to do it, I had a list of 5-10 stocks that I liked and had studied, then I'd go 90% x current price, 1 month out.  The list at the time included Dell, Visa, Advanced Auto Parts and Cisco. 

 

 

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By collateral is how I used to calculate the returns.  I haven't done any for a year or so because of my job.

 

In response to the second question, if the stock at that lower price is something you want to own, the return looks good.  I had a friend who made a disaster of a trade about two years ago...FSLR puts at $90 strike with a month out had decent premiums so he went in and sold 2 of them...got put the stock and at that point it wasn't a disaster but he decided to sell calls on it "to make it back".  Anyways, that was his relocation package so he lost about 80% in a 3 month period and ended up in a not so pleasant part of Austin. 

 

The way I used to do it, I had a list of 5-10 stocks that I liked and had studied, then I'd go 90% x current price, 1 month out.  The list at the time included Dell, Visa, Advanced Auto Parts and Cisco.

 

That was a high tuition cost for your friend. The first gate has to be the price at which you would get put to you would have a large margin of safety. If that is not the case walk away.

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For deep out of the money puts, I take the return to be roughly equal to the premium divided by the collateral requirement. Some people take it as the risk of exercise * the cost divided by the premium (but how do you quantify the risk for an of the money option?).

 

as an aside, do people think getting 10.5% annualized on a 4month put that is 33% out of the money is a good deal in this environment?

Why calculate returns based on collateral requirements? I don't think that makes a lot of sense. You're not doing that when you buy stocks or bonds right? I'd say calculate returns based on capital at risk.

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For deep out of the money puts, I take the return to be roughly equal to the premium divided by the collateral requirement. Some people take it as the risk of exercise * the cost divided by the premium (but how do you quantify the risk for an of the money option?).

 

as an aside, do people think getting 10.5% annualized on a 4month put that is 33% out of the money is a good deal in this environment?

Why calculate returns based on collateral requirements? I don't think that makes a lot of sense. You're not doing that when you buy stocks or bonds right? I'd say calculate returns based on capital at risk.

 

In my response above what I meant I do for calculating my effective annual percent return is

 

% return = [{(net put premium)/(strike price-net put premium)}*100]*(365/days to expiration)

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I would do:

 

Premium / (strike*multiplier - premium)

 

ie, MSFT $27 Jan 14 puts are $1.90 right now.  The return would be 7% over the next 10 months (if MSFT is over $27 in 10 months).

 

That is the unlevered return.  Anything else (assuming broker collateral required, or probabilities of exercise) may produce a result that is an inflated estimate of return due to application of leverage. 

 

I'll sell puts on something if its getting close to a price I may buy at (or if I already own, using a stike at a price I'd want to buy more at).

and the inverse for calls

I'll sell calls at a strike at a price I'd be willing to sell at. 

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I see, so people are saying something like:

 

put premium / (Capital outlay if exercised * probability of exercise (est.)) * (time to expiry*annualized adj.) = return. (and minus interest on collateral if you have to pay it)

 

I don't understand using a probability. Here is what I do with a specific example.

 

This morning I wrote 67.5 strike March 16 puts on NOV. I wrote them for $61 a contract. My commission per contract worked out to be $0.39. So I cleared $60.61 per contract. So if I get put to I have to pay $6,750-$60.61 = $6,689.39 per hundred shares. Note I use IB and there is no commission on purchases when I am put to.

 

So my "annual return" is

 

($60.61/$6,689.39)*100*(365/4) = 82.68%

 

 

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I see, so people are saying something like:

 

put premium / (Capital outlay if exercised * probability of exercise (est.)) * (time to expiry*annualized adj.) = return. (and minus interest on collateral if you have to pay it)

 

I don't understand using a probability. Here is what I do with a specific example.

 

This morning I wrote 67.5 strike March 16 puts on NOV. I wrote them for $61 a contract. My commission per contract worked out to be $0.39. So I cleared $60.61 per contract. So if I get put to I have to pay $6,750-$60.61 = $6,689.39 per hundred shares. Note I use IB and there is no commission on purchases when I am put to.

 

So my "annual return" is

 

($60.61/$6,689.39)*100*(365/4) = 82.68%

Shouldn't it be (1+$60.61/$6689.39)^(365/4)-1=127%?

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I see, so people are saying something like:

 

put premium / (Capital outlay if exercised * probability of exercise (est.)) * (time to expiry*annualized adj.) = return. (and minus interest on collateral if you have to pay it)

 

I don't understand using a probability. Here is what I do with a specific example.

 

This morning I wrote 67.5 strike March 16 puts on NOV. I wrote them for $61 a contract. My commission per contract worked out to be $0.39. So I cleared $60.61 per contract. So if I get put to I have to pay $6,750-$60.61 = $6,689.39 per hundred shares. Note I use IB and there is no commission on purchases when I am put to.

 

So my "annual return" is

 

($60.61/$6,689.39)*100*(365/4) = 82.68%

Shouldn't it be (1+$60.61/$6689.39)^(365/4)-1=127%?

 

yes, thanks for correcting. So I am doing even better than I thought, lol!

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Does anyone with experience know how assignments of option contracts occurs in real life?

 

E.g.

You sell covered calls 6 months away at a certain strike. Let's say the premium is close to zero.

It's one month later and the stock reaches the strike price.

 

Question:

- Is assignment immediate or do you have a couple of minutes or hours notice?

- Is assignment guaranteed? I.e. could the other party wait for the stock to rise even higher thus ensuring a lower exercise price but giving the seller uncertainty about what will happen?

- Can you induce the assignment at the strike if you want to?

 

 

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Does anyone with experience know how assignments of option contracts occurs in real life?

 

E.g.

You sell covered calls 6 months away at a certain strike. Let's say the premium is close to zero.

It's one month later and the stock reaches the strike price.

 

Question:

- Is assignment immediate or do you have a couple of minutes or hours notice?

(Almost) No-one is going to exercise early unless you have a deep in the money call and a there is a dividend coming up. Otherwise you have to wait till maturity.

 

- Is assignment guaranteed? I.e. could the other party wait for the stock to rise even higher thus ensuring a lower exercise price but giving the seller uncertainty about what will happen?

See above. Of course the other party is going to wait. Why give up on the time value of an option?

 

- Can you induce the assignment at the strike if you want to?

NO. It's called an option for a reason. And if you sell a call you sell the option to someone else.

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Just wanted to point out something, maybe obvious.  But remember, the person who buys has the right, but not the obligation to the contract.  (Call == right, but not obligation to buy stock at strike price at any time between now and the end date - for American style options.  Put == right but not obligation to sell the stock at strike price at any time between now and the end date).

 

The seller of that option is basically the opposite side of the buyer.  So they have the obligation to buy/sell the stock at the strike price at any time between now and the expiration date.  Now, as stated, usually the buyer will not exercise their option if there is any time value left in the option unless there is something else going on.  But as the seller you must be prepared to to fulfill your obligation at any time.  (For american style options.  For European style, the obligation is only at the end date)

 

So if you own the option you can force exercise at any time by telling your broker.  If you sold the option, you can't do anything if this happens other than close the position asap or keep the stock/short.

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  • 2 years later...

Are there any avenues for selling European-style options in American stocks? (a la Buffett selling European-style puts on the indices).

 

Way back when, the option exchanges allowed customers an opportunity to customize option contracts.  You could request a price for an option contract with your parameters.  I don't believe it ever really took off.  The idea was to bring in some of the option flow that was trading off the floor and bring it down to the floor.  Not sure if the exchanges still offer that but you could try and ask through your brokerage house. 

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I use a spreadsheet similar to the one showed here:

 

http://trading-journal-spreadsheet.com/wp-content/gallery/default/trading-journal-spreadsheet-trading-log.jpg

 

Selling European style options on American stocks? Not that I know off, the only options I've ever bought or sold were American. I suppose you could ask a bank to buy a custom made OTC option from you, but that will becoma expensive. I would stick to the general American style options.

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