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.

the great compromise

An investor asked about a "...favorite investment strategy..." & "...backtesting?" 

I sell puts, then calls in my IRA against ETFs.  Currently, I'm using XLE - the energy ETF - exclusively.  (I've used DIA, SPY, EEM, EFA & TLT.)  I'm reluctant to use individual equities because I still hear footsteps as a result of once highly respected companies like Enron, Tyco, SunMicrosystems crunching investors at this century's turn.  Even Apple was painfully in the single digits back then.  With ETFs, if I get put under lousy circumstances, as I did with XLE a few months ago, at least I own a diverse mutual fund.

Backtesting?  I compare my option selling performance to the buy & hold performance of the underlying ETF.  Versus the 5 buy & hold market outcomes below, my performance is as follows, which is actually how it must be when selling options:

1. Through-the-roof with buy & hold?...as I sell puts, then calls, I generally do well but underperform.
2. Up-modestly w/ buy & hold?...I generally outperform.
3. Flat?...I generally outperform.
4. Down-modestly?...Generally outperform.
5. Into-the-tank?...I generally outperform, while still getting beat up!

Here's a good example:

• On 7/21/20, XLE was at $38.38.  I sold the XLE 8/21/20 $42 covered calls & received a $0.53 premium.  XLE closed at $37.55 on 7/27/20, down $0.83 from July 21.  Of course my XLE shares were also at $37.55 on July 27's close - down the same 83 cents - but I have the 53 cent premium in my IRA's back pocket.  A hedge against the 83 cent loss.
• A bit later on the same July 21, XLE was at $38.22.  I sold the XLE 8/21/20 $38 put & received a $1.67 premium.  If this put were assigned at 7/27/20's close, I'd pay the $38 strike price for the then $37.55 XLE, a 45 cent principal loss.  But I'd have the $1.67 in my IRA's back pocket.  While an XLE buy & hold dropped 67 cents from $38.22 to $37.55, I'd have the $1.67 premium minus the 45 cents in principal loss.  Another hedge against an XLE loss.

For me, the most frustrating buy & hold outcome to compete with is when my XLE goes through-the-roof.  My sell puts, then calls strategy generally does very well then, but not as well as buy & hold.  The great compromise of option selling!

I don't consider implied volatility, greeks. (I don't understand, never studied them.)

Some put sellers try to avoid assignment, hoping to capture the "free money" by selling puts that are so far out-of-the-money that they'll rarely get assigned/put.  My fear of doing so is the risk of collecting only a $0.25 put premium & watching the underlying go up $5.  I'm getting the impression that a lot of put sellers are satisfied with generating $500 a week in put premiums by selling these puts.  Upon worthless expiration (& no assignment) they consider the $500 as "free money" & "beating the market."  For these put sellers, implied volatility & greeks may be important as they try to avoid put assignments.  And that's not wrong.

But as I sell puts, I demand that I beat the buy & hold market, along with collecting a put premium.  Sometimes I do.  Since 3/23/20's ebb, with the remarkable market appreciation, that's been tough.  I've often wondered, "why sell puts, then calls if all I can do is collect premiums but can't beat the buy & hold market?"

When I sell puts, I know that I'm limited on the upside to only the amount of premium received.  So I sell puts that are barely out-of-the-money & that pay a high premium.  This high premium helps me compete with strong appreciation of the underlying stock.  I'm almost inviting put assignment, understanding that the way to make real money is to own stock.  Yet, owning stock is riskier, so I sell covered calls after I get put.  Selling covered calls provides a hedge versus depreciation. 

In my sell puts, then calls strategy, selecting strike prices for my covered calls depends on whether I'm above or under the water.  If I'm under the water, as I am today with XLE, I'll choose a call strike price that gets me a minimum 10% annualized premium yield.  I can go quite a bit out-of-the-money for this & then I have the opportunity for appreciation.  If I'm above the water, I'll sell covered calls that are barely out-of-the-money to capture a higher premium & defend myself against depreciation.

Today, the first business day after option expiration Friday, I sold covered calls against my XLE when XLE traded at $39.05.  I sold the July 17, 2020 XLE $42 calls & received a $0.76 premium.  Because I'm under the water in my 6 month sell puts, then calls effort with XLE, today's calls are "quite a bit out-of-the-money" & I received my "minimum 10% annualized premium yield" (actually, 28%).  After this trade, with XLE then at $39.11, I had sufficient cash availability to sell 1 XLE cash secured $39 put, expiring 7/17/20 & paying a rich $1.87 premium; a "barely out-of-the-money" put.  

With my sell puts, then calls strategy (attitude?), I just can't see how implied volatilty & greeks can help.               

where to "put" cash?

There's an abundance of blogging today on cash-like investments in this low interest rate environment:  FDIC savings accounts, CDs, money market funds, brokerage cash accounts.  Even ETFs that invest in short duration bonds.  As I sell puts, then calls, I'm not interested in cash-like returns.  But if you're inclined to sell cash secured puts, here's an idea:

This afternoon, SPY, the S&P 500 ETF, traded at $306.57.  I looked at the option chain for the June 19, 2020 expiry.  The $306 puts showed a $6.32 Bid & the the $264 puts showed a $0.47 Bid.  Let's consider a $100,000 account, with all the money positioned in the account's core position to secure the selling of puts. With $100,000, I'm able to sell 3 of the $306 puts, or 3 of the $264 puts.

I sell puts rather aggressively.  Just a bit out-of-the-money.  I often don't mind an assignment...getting put to buy SPY at the strike price.  So I'm inclined to sell the $306 puts. 

• 3 puts require cash security in the core position of 300 X $306 = $91,800.  
• At the $6.32 Bid, I'd receive a premium of 300 X $6.32 = $1,896.  
• $1,896/$100,000 = 1.896% over 17 days until 6/19/20's expiration.  
• That's a 40.7% annualized premium yield.  

The core position of $100,000 + $1,896 also earns the modest interest rate provided by the core position's investment.  But I can hardly call this cash secured put investment cash-like.  There's a great chance of assignment.  More accurately, I call it a stock market investment & an aggressive one.

But the $264 puts are a different story. 

• 3 puts require cash security in the core position of 300 X $264 = $79,200.  
• At the $0.47 Bid, I'd receive a premium of 300 X $0.47 = $141.  
• $141/$100,000 = 14.1 basis points over 17 days until 6/19/20's expiration.  
• That's a 3.0% annualized premium yield.  Cash-like investors would die for 3% today.

With my choice of the $306 put, SPY needs to drop only 57 cents to get into assignment territory.  With the $264 put, SPY needs to drop over $42 to hit assignment territory.  With the $264 put, a much lower chance of assignment & a higher chance of what often feels like "free money."

Some put selling investors use these way out-of-the-money puts (like the $264s) to serve as a cash alternative.  I still call the $264 put a stock market investment, but a conservative one.

One beauty of selling puts, then calls is an investor's ability to select risk. 

       

when the goin' gets tough

A good option selling friend of mine once said to me, "An option seller's mettle is really tested when he gets beat up!" 

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 also 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.

On 12/23/19, with XLE - the energy ETF - "struggling" at $59.88, I dedicated my entire option selling strategy to XLE by selling the January $59.71 puts for a $0.93 premium.  On option expiration Friday, 1/17/20, I was assigned to buy XLE at $59.71 because XLE closed at $59.12.  I killed it during that January month.  But I've been crunched since.  Down about $175K in my IRA.  My mettle is tested.  

After January's assignment to buy XLE, I sold covered calls versus my XLE shares.  As I applied my sell puts, then calls strategy since then, I've gotten put & called, & I've also repaired my sold puts & calls.  I've generated a ton of option selling premium; my goal is to generate a premium yield that's greater than 10% annualized.  With the volatility index high, that's easy to do.  In fact, I've recently used some of my rich premiums to buy protective calls - my hedge against a rising XLE market.  XLE's quick & strong recovery since March 23 has made it tough for me to beat buy & hold.  

My monthly performance is as you'd expect versus the above market outcomes, yet frustrating:
ending...       option selling         buy & hold

1/17/20          +0.65%                    -1.23%

2/21/20           -7.4%                      - 8.4%          

3/20/20           -45.5%                    -52.2%

4/17/20           +10.7%                   +33.5%

5/8/20*            +13.3%                   +14.2%

*The May monthly options expire on 5/15/20, but my 13.3% presumes they expired on 5/8/20.  My sold XLE puts are out of the money, therefore this presumption is quite fair for this evaluation.   

I sometimes wonder if it's worth it to sell puts, then calls.  Perhaps I should simply use Fidelity Contrafund.  I retired from Fidelity Investments in 2017, & during my 10 years there, I used only Fidelity Contrafund in my 401K.  But I then realize that I'm not good at picking market direction.  That's why I sell puts, then calls, & hope for the 3 middle market outcomes above.  Since 1957, when the S&P index began using 500 companies, it's up about 8% a year.  Quite middle of the road.          

To "buy low," use a limit order?...or sell puts?

I sellputsthencalls against exchange traded funds in my IRA.  In the last month, I had an interest in buying XLE, the ETF that holds 28 energy stocks.  On 12/23/19, it traded at $59.88, but I wanted to buy low, at $59.71.  (In this discussion, all XLE prices reflect the dividend adjustment for the $1.79 div that was paid on 1/3/20; except for the XLE put premium, which was not div adjusted.)

Consider 2 alternatives:

• I could have used a limit order to buy XLE lower, at $59.71, good-'til-cancelled.  Had I done so, since XLE dropped below $59.71 on 12/30/19, I would have been a buyer on that day.  I'd have then sold the 1/17/20 covered calls against my XLE shares to help me to sell high.  
• Instead of using a limit order, I chose to sell a cash secured put against XLE to help me to buy XLE low.  I sold the XLE 1/17/20 put with a $59.71 strike price & was paid a 93 cent premium into my IRA on the next day.  Of course, for accepting 93 cents, I also accepted the obligation to buy XLE shares at exactly the $59.71 strike price if the price of XLE dropped below $59.71 from the time I sold the put until the close of option expiration Friday, 1/17/20.  During that time frame, XLE moved below & above $59.71 a few times.  On Friday, 1/17/20, XLE closed 59 cents below the strike price at $59.12, the put was assigned against me, & I was forced to buy XLE shares at the $59.71 strike price.  My put premium adjusted cost for the XLE shares was $58.78.  I was pleased.  My XLE shares were bought quite low.  But since then, my XLE shares are trading lower, currently at $57.28.  I want to sell the 2/21/20 covered calls against my XLE shares, but with XLE this low, I'm waiting for XLE appreciation.

To "buy low," is it better to simply use a limit order?...or to sell puts?

sellputsthencalls to "select" risk?

As I sellputsthencalls I don't use greeks.  The premium numbers tell me all I want to know.  (This discussion features puts, but I also apply similar consideration to calls.)

On the last monthly option expiration Friday, 12/20/19, all of my options - SPY & EEM puts, both short - expired worthless (because both markets went through-the-roof).  On Monday, 12/23/19, the first business day after the December month's expiration, my entire option selling portfolio was available as cash available to trade...$448,000.  I disclose the amount of my Rollover IRA that I sellputsthencalls against because that disclosure adds to the feel of risk.

Normally, I'd sell as many cash secured puts as possible against SPY (S&P 500), to help me to buy SPY a bit lower (or DIA [Dow Jones Industrial Average]).  I'd go out to the next monthly option expiration date, in this case 1/17/20.  I'd generally choose a put that's only slightly out-of-the-money, so that I can get the highest premium.  To evaluate risk, on December 23rd I looked at 3 strike prices, with SPY at $321.56:

• 14 puts     $321.50 strike price     $2.91 BID     13.2% premium yield     $4,074 total premium
• 14             $321.00                       $2.74             12.5%                            $3,836
• 14             $317.00                       $1.80               8.3%                            $2,520

To calculate premium yield, I divide the BID by the strike price & annualize it.  I know that if the market for SPY stays flat over the next month my return is the premium yield.  Because I don't guess SPY's direction over the next month - I'm not good at doing that - I presume, & often hope that SPY does stay flat.

In the option month ending on 12/20/19, my actual sellputsthencalls return in my IRA was 16%.  My option selling allocation that month was about 90% SPY & 10% EEM (emerging markets).  16% is very good, but a simple buy & hold strategy (with no option selling) using these 2 ETFs would have produced 36% & 58% annualized, respectively.  In my sellputsthencalls strategy, I realize that I'll always underperform a through-the-roof performance by the underlying stocks.  But this strategy's worth it, I think, because in the other 4 performances by the underlying - up-modestly, flat, down-modestly & into-the-tank - option selling generally wins.

Although December's underperformance is understandable, I thought that this January I'd chase December's lost opportunity by investing in energy.  Plus, I've been a fan of the energy market since oil tanked in 2014.  I've made a little money on the energy market at times, but currently, I'm in a position in my taxable account to lose a reasonable amount with the 1/17/20 expiration of long call options.  Despite being an avowed sellputsthencalls trader, I have purchased some calls speculatively; & mostly unsuccessfully.  So going into the January month, I was in the mood to catch up a bit.  I considered Exxon Mobil with my $448,000; I could sell puts against XOM, trading at $70.12:

• 64 puts     $70.00 strike price      $1.05 BID     21.9% premium yield     $6,720 total premium

The risk of selling puts?...getting put.  It's a risk because the underlying stock can drop...the risk of stock ownership.  Of course the risk of XOM ownership is much greater than the risk of SPY ownership, since SPY is a mutual fund.  The feel of that risk?...SPY's total premium (from my just out-of-the-money put) for my IRA is $4,074, a 13.2% premium yield; XOM's total premium is $6,720, a 21.9% premium yield.  I love $6,720, but I'm deathly afraid of $448,000 allocated to one company (XOM).

But how about XLE, the ETF that invests in 29 energy stocks (its largest position is XOM)?  With XLE at $61.73:

• 73 puts     $61.50 strike price     $0.91 BID     21.6% premium yield     $6,643 total premium

Feeling risk?  To sell cash-secured puts against my entire $448,000 sellputsthencalls portfolio, I considered 3 choices, all barely out-of-the-money:

• SPY, producing $4,074 in total premium; 13.2% premium yield.
• XOM, producing $6,720; 21.9%.
• XLE, $6,643; 21.6%.

Looking at these choices, I could feel the risk of each.  I'm frankly surprised that I could receive nearly the same total premium from the exchange traded fund XLE (a mutual fund) as from XOM.  This enabled me to easily preclude selling puts against XOM; why accept the risk of an individual stock, XOM, when the much more diverse XLE gets me essentially the same premium?

Rather than applying my more conservative strategy of the past 2 years & trading against SPY, I chose to sell puts against XLE, whose price ticked down to $61.67 at trade time:

• 73 puts      $61.50 strike price      $0.93 BID (execution)     21.96% premium yield     $6,738.56 total premium

In "selecting" risk during this January month, I chose to accept more, & I could actually feel the risk:

• XLE's total premium $6,643 versus SPY's $4,074. 
• XLE's premium yield of 21.6% vs SPY's 13.2%.
• The risk of getting put a small S&P 500 sector rather than the broad S&P 500.
• The risk of chasing performance - December's lost opportunity; & even my taxable account's anticipated energy market losses (where I've owned XLE calls).
• Although I'm not good at market guessing, SPY is at all time highs.  XLE is very low in comparison to its $100 price during 2014's oil peak.  Investors are wondering about an S&P 500 decline.  We all wish we could buy SPY at its March 9, 2009 lows.  Perhaps XLE represents that chance?  Perhaps I should select XLE's risk because there's less chance of it tanking than there is of SPY tanking?  XLE, less risky? 

As I sellputsthencalls to "select" risk, I'd be delighted to hear comments.  In particular:

• Am I missing something as I ignore greeks?
• Am I "selecting" too much risk by generally selling barely out-of-the-money puts?  I get assigned quite a bit; only about 60% of my sold options expire worthless.
• Is it appropriate to suggest that XLE exhibits less risk than SPY because SPY is at a market peak, & XLE is far below one?
• I like to sellputsthencalls because it's very quantitative.  I can measure the risk & feel it, then "select" it. 
• I often presume - & hope for - a flat market.  Should I make more effort to pick direction?