I bought a put, it's up 80%, expires in 4 months...sell it or hold longer?

An option newcomer asked the question in the above title.  My answer:

In my strategy, I sellputsthencalls - I sell to open cash secured puts (occasionally naked puts) & then covered calls.  Recently, I uncharacteristically did buy a call to open.  And it did force me to consider your above question after you bought a put that quickly made you 80%.  I bought a call versus XLE, the energy ETF.  In my sellputsthencalls strategy versus XLE, I made 2 critical errors in which I lost money.  So I bought a long term XLE call to catch up, & importantly, to protect my sellputsthencalls strategy against strong XLE appreciation.  I was bullish on oil & the energy stocks.  The XLE call became profitable, but not enough to cover my earlier loss.  But time until expiration was running out.  So I sold the XLE call well before expiration to capture the available profit, even though I was bullish on XLE.  (You're never wrong to take a profit.)  Continuing with my bullishness, I then bought another XLE call with an expiration date that was 1 year longer.  About 10 months before that call's expiration, all of my loss from the 2 critical errors was covered, plus I was able to grab a few more dollars beyond my loss.  So I sold my call & put it behind me.  

SPY closed @ $412.20, but its $412 covered call was not assigned against me.

Yesterday, option expiration Friday, 4/21/23, my 100 shares of SPY closed @ $412.20.  I was pleased because I wanted my 4/21/23 SPY $412 covered call to be assigned, forcing me to sell my 100 SPY @ $412.  But today I saw that it wasn't assigned.  It expired worthless & I still own the 100 SPY @ $412.20 - actually, a 20 cent benefit to me.

When I worked in the industry, & this happened to my clients, they might protest, "My covered call closed in the money by 20 cents but I wasn't forced to sell my stock.  Did your broker/dealer (Fidelity, until my retirement) stiff me?" 

We often say with the above SPY covered call, "If SPY closes on expiration date above $412, your $412 covered call will be assigned, forcing you to sell your SPY @ exactly $412." That's a "pretty fair rule" of covered call selling.

But to be more accurate, for this $412 covered call to be assigned against a seller like me, a buyer of the 4/21/23 SPY $412 call has to exercise his right to buy SPY @ exactly $412.  Then, the Options Clearing Corporation randomly assigns this exercise to a broker/dealer like Fidelity that has this covered call among its clientele.  Then the broker/dealer like Fidelity randomly assigns it to a client that has sold this covered call, like me.  If any of these $412 calls were exercised yesterday by the owner of the call, I was never randomly picked for an assignment. 

Yesterday, SPY traded above & below $412 all day.  At 3:51pm ET, it was at $411.93, but then closed at $412.20.  During the day, a buyer of this $412 call might have asked himself, "Why would I exercise my call to buy SPY @ $412 when I can simply buy it in the market when it's trading at $411.50?"

When I sell a SPY $412 covered call, I'm creating a contract.  Because I received a premium, I accepted an obligation to sell my SPY @ $412 if the call option is exercised AND assigned to me. 

Is it worth it to use margin to sell naked puts?

Last year, I had a margin account with no outstanding loan.  It held $5K in CORE MMF & $28K in FCNTX (Fidelity's Contrafund).  In August, with SPY @ $428, I wanted to sell a SPY $393 put.  I couldn't sell a cash secured put with only $5K in CORE.  So I sold (only) ONE naked put, hoping it'd never be assigned.  In October, after a couple of put repairs (roll-outs) & SPY @ $369, I was assigned to buy 100 SPY @ $391 (my repaired strike price).  It created $34K in margin debt.  I then sold covered calls & also collected 1 dividend.  In February, '23, with SPY @ $407, my $401 covered call was assigned so I was forced to sell my 100 SPY @ $401.

Over the August to February investment period, I received $1.78/share in dividends, $22/share in put/call premiums, & $10/share in capital appreciation.  But, at an average margin rate of 11.5%, I paid $10/share in margin interest. 

Over the 6 month period, my credits were $33.78/share, or a $3,378 gain.  On a $33K start-up value, that's over 10%.  But my very expensive $10/share in margin interest ate up $1,000 of my gain, leaving a $2,378 net gain, or just over 7% in net gain.  Margin interest ate up about 30% of my credits. 

Margin risk?  I was assigned to buy SPY @ my $391 strike price when SPY traded at only $369.  Although I had a few dollars in SPY put premiums in my back pocket, I was getting crunched.  Still, at only $369 a share, my SPY shares (& FCNTX shares) were able to comfortably support my $34K in margin debt.  But if SPY dropped further (COVID brought it down to $253 in 2020), a margin call could have been presented to me, forcing me to sell some SPY shares at an awfully low price. 

where to "put" cash? - 2nd edition - to help pay bills!

See my 6/2/20 post, where to "put" cash?  It was an idea that offered an alternative for investors who are unhappy with money market returns.  But I put the idea to work this month in my own account.  It's a cash account that's used for checkwriting, bill pay, ATM withdrawals, pension & Social Security deposits.  It holds about $120K in cash that's in a money market fund that pays a 7-day yield of 0.01%.  

On 8/6/21, I sold 23 cash secured puts against XLE, the energy ETF.  XLE was trading at $49.69.  I sold the $43 puts that expired on 8/20/21.  I received a $0.07 premium that netted $152.12.  On 8/20/21, XLE closed at $45.89 & my puts expired worthless - i.e., I was not assigned to buy XLE shares at $43.  All I earned was $152.12, representing an annualized yield of over 3%.  Because this account holds "sacred" cash (especially in my wife's eyes), I would have been really displeased if XLE closed below $43 & I'd have been assigned to buy XLE at $43 (my risk).

Today, I did similarly.  XLE traded at $47.69.  I sold 22 cash secured puts against it - the $40 puts that expire on 9/17/21.  I received a $0.13 premium that netted $270.93 for the 25 day commitment, again representing an annualized yield of over 3%.  I have a $7.69 cushion until a $40 put assignment - a 16% cushion.  

What's interesting is that prior to the trade, I observed my monthly bill pay debit of $1,548.83 for my credit card against this cash account.  After my cash secured put trade, that debit was reduced to $1,277.90 - by exactly $270.93, today's put premium.  

Selling puts (& calls) can be helpful - with a controlled amount of risk - to help pay for routine expenses like bill payments.  This strategy can also be applied to finance Required Minimum Distributions.          

defense versus a 10% correction

On another forum, an investor asked for an idea to protect against a 10% decline.  My reply:

"I'm not defending myself against a 10% pullback, in large part, because I don't guess the market.  But if I wanted to defend against a 10% pullback, I might sell a cash secured put against SPY, the ETF that holds the S&P 500.  An example:

SPY is trading at $444.45; close to an all-time high.  A 10% drop would take it to $400.  To be defensive, I'd sell an SPY put with a $400 strike price that expires on 12/17/21.  The buyer of that put would pay me $7.10 (per share).  This put buyer is often a speculator that's making a guess that SPY will fall toward or below $400 between now & 12/17/21. That $7.10 would be paid to my account tomorrow & it's non-forfeitable.  It's mine.  I could spend it on investments, gasoline, groceries.

But the $7.10 isn't free to me; there's a catch...an obligation for me:  if SPY drops below $400 between now & 12/17/21, I'm obliged to buy SPY at exactly $400.  Even if it drops to $390, or to $300 or to $0 (the risk of this idea).  When I'm forced to buy it at $400, my cost basis is $400 minus $7.10 = $392.90.  

I do not have to own SPY shares to make this trade.  But I must hold $400 cash (per share) in my account to secure the $400 buy obligation. 

If SPY stays above $400 until 12/17/21, the put option expires, & my obligation to buy SPY at $400 ceases.  All I have earned is the $7.10.  What's my return if SPY doesn't drop to < $400?...$7.10 divided by the $400 on reserve = 1.8% for about 4 months, which annualizes to over 5%.

If SPY drops to < $400, I'll be obliged (forced) to buy SPY at $400, a 10% discount from today's price.  (Actually, at $392.90!)  

A pure defensive move against a 10% drop would be to stay in cash.  And then, after SPY drops to $400, buying it at the 10% discounted price.  Selling these cash secured puts pays you $7.10 while you wait for the 10% correction."    

Sell puts, then calls...to eliminate guesswork?

In my primer, Selling Options...Simply Called and Simply Put, I insist that my strategy eliminates the need for guesswork.  All I need to do is select an expiration - I use monthly options; & a strike price that's attractive to me - a strike price at which I don't mind a put or call assignment.  I.e., I'm amenable to being put-assigned to buy or call-assigned to sell at my strike price.  Of course, the premium that I receive for selling the put or call must be attractive compensation for my obligation to buy or sell the underlying.  I have no need to guess the future direction of the underlying's price (I even admit that I'm not good at doing so).

To measure my performance, since I only use monthly options against ETFs, I evaluate the month between option expiration Fridays.  I measure my option selling strategy versus a buy & hold strategy for the ETF.  I recognize 5 market outcomes:  

1. through the roof.
2. up modestly.
3. flat.
4. down modestly.
5. into the tank.

If the market for my ETF goes through the roof, my option selling strategy will do very well, but not as well as buy & hold.  If the market goes into the tank, I'll also lose, but not as much.  But if the ETF's market is flat, or up or down modestly, option selling is often a real winner. 

No need to guess?  I sell the put or call & often hope for 3 outcomes:  up or down modestly, or flat.  But if the underlying goes through-the-roof, even though I do very well, I am often disappointed to leave money on the table - to not get it all!  And if the underlying tanks, even though I lose less, I'm often disappointed about the loss! That's when, at times, I apply a repair strategy (a roll strategy).  It's my  sometimes-mistaken effort to out-guess the market. 

On 12/23/19, I began using XLE - the energy ETF - exclusively in my sell puts, then calls strategy.  Starting with $467K.  In almost all of the 19 months through 7/16/21, my option selling strategy's performance compared as expected versus a buy & hold performance vis-a-vis the 5 market outcomes above.  But my overall 19 month option selling strategy dismally under-performed buy & hold.  During this 19 month period, XLE dropped 13%, from $61.67 to $53.65 (including the $4.97 in divs).  My option selling strategy lost 18%, down to $382K!  I would have expected a single digit loss.

Although I had some successful repair strategies, I made 2 critical errors using them.  In March, 2020, I repaired my strike price from $32 to $26, when XLE was around $23.  I guessed that XLE would stay (COVID-) weak, but it moved to nearly $34.  In March, 2021, I repaired from $47 to $55, when XLE was around $53.  I guessed that XLE would remain strong, but it dropped to around $49.  

The March, 2020 error cost me $41K & the March, 2021 error cost $21K!  Without these mistakes, my 7/16/21 value would have been $444K, down only 5% & in line with my expectation.             

 

  

   

Repair or get put?

With XLE - the energy ETF - at $39.29 this option expiration Friday afternoon, 12/18/20, I was short today’s $40 put.  I’ve been using XLE exclusively for my IRA’s Sell Puts, Then Calls strategy since 12/23/19, when I sold the $59.71 put (dividend adjusted from $61.50).  I was assigned that $59.71 put the following month.  By 3/23/20, XLE was in the $20s.  I’ve been selling puts, then calls against XLE for a year.  I anticipate that Monday, 12/21/20 is XLE’s quarterly ex-dividend date; for about 50 cents.  A few months ago, I bought & still hold the XLE 1/21/22 $60 calls, as a hedge against a rapidly appreciating XLE market - my Sell Puts, Then Calls strategy limits me when XLE goes through-the-roof.

In considering repairs (rolls) for my in-the-money short puts & calls, I usually wait until option expiration Friday to bleed out the time value for my buy back (buy, to close).  Today, as part 1 of my repair, I could have bought back my December $40 put for $0.74 (only 3 cents of time value).  I would have then sold-to-open the 1/15/21 $40 put for $2.36 ($1.65 of time value), providing a net credit of $1.62.  For a 28 day commitment, a 52.8% annualized premium yield. Instead of the $40s, I could have sold the $39s for $1.79, which is my usual, barely-out-of-the-money modus operandi.  But I’m anxious to catch up to $59.71, & bullish, so I considered the already-in-the money $40s. 

My other consideration:  allowing my $40 put assignment today, forcing me to buy XLE at $40; and then selling the 1/15/21 $42 covered call, receiving a 60 cent premium.  For 28 days, a 19.9% annualized premium yield.  Since I’m hard up for appreciation, the chance for XLE to move from $39.29 to the $42 strike price, nearly 90% annualized, is attractive.  My long $60 calls would also be helped with strong XLE appreciation. And by getting assigned to buy today, I’m the owner today & would be eligible for the quarterly dividend that most likely goes ex-div on Monday.

I chose the $40 put assignment & I’ll sell a covered call next week; because I’m in the red, big time.  If I was in the black, I might have repaired.  I welcome hearing what you’d do.