Put options on ProShares Ultra Russell 2000 (UWM) have become hard to resist for me lately. I understand after such a big run up the risks are higher of a bigger correction, but the January 2012 options have extreme pessimism built into them. Before today I was already short one contract at the January 2012 45, 40 and 35 strikes in my Interactive Brokers account. I also already had two January 2012 30 strike naked puts in my TD Ameritrade account. Those 30 strike puts are the ones that have the most allure to the right now.
While UWM was trading at $41.70 this morning I sold one January 2012 $30 strike naked put at $4.30 and received $428.99 after commissions. I entered this order late last week to see if it would hit on a dip. Friday’s fall didn’t seem to have enough in it, but I guess some left over fear was out there this morning and my order hit. The allure this contract has comes from its risk/reward outlook. With 51 weeks to go before it expires I’m looking at an annualized return of 17.0% (16.7% not annualized) and have 38.35% downside protection before I take a loss. UWM can even lose over 28% and I’ll still finish with a full profit. I estimate that be around a loss of 13% or more in the Russell 2000 index just to take my full profit and 17-18% before I lose a penny.
I’m not all about investing not to take a chance of losing any money, but when I can pull in an annualized 17% with that much downside protection I have a hard time not taking the chance. If the small caps do drop that much I won’t mind buying in so low and selling calls at the $30 strike as I wait out the recovery. More than likely we won’t drop that much and I’ll be able to add more exposure as UWM drops or as these contracts lose value while UWM heads sideways or higher. I’m still not fully invested, so I’ll continue to add more exposure on every dip or spike in fear and probably on some random other days when I’m feeling more bullish. The only real risk I see in this contract right now is the lack of liquidity. There are only a handful of contracts showing in open interest and I have three of them and have two of my clients in three more. If I ever wanted to buy them back (don’t see that happening any time soon) I’d surely have to pay a premium.