Simply writing out your thoughts on your account can do a lot to clarify what you need to do with your next trades.  At least that’s how it worked for me today.  By the time I finished writing today’s month-end summary for January, I knew I needed to take on some more risk.  I had no contracts set to expire in March going into the day and had no exposure to large caps stocks.  That’s somewhat ironic considering that I was trimming my portfolio to avoid some downside risk and yet I kept the riskier assets in my holdings.  I solved that by getting back into the DIA.

While DIA was trading at $139.77, I sold two DIA March $142 puts for $3.58 each and bought two DIA March $138 puts for $1.61 each.  I received $394.39 for the $4 put spread after paying $1.61 in commission.  I priced out March and April contracts for naked puts on DIA and even entered a limit order that stood for five minutes, but I cancelled the order after I thought about it a little longer.  The upside potential was relatively small and my downside cushion was only 1.2%.

I removed my cushion by switching to a put spread instead of a naked put, but capped my losses at 1.45%.  I was only going to sell a single naked put originally.  That would’ve brought in less in premiums than these two put spreads.  I made the change because I didn’t think a buffer of 1.2% on the naked put was enough to risk so much more downside pain.  I have six weeks and a day for this trade to play out.  I don’t think the Dow will be within 1% of its current level by then.  I don’t know if it’ll be higher or lower, but either way works for me.  If it goes up, I’ll continue on my path towards making 15% this year.  If large caps reverse course, my losses will be limited and I will have plenty of cash to put back to work when I think prices have fallen enough to reverse the risk/reward picture in my favor.

I need more slated for March still.  Today’s trade was something to get me started while I wait for the dust to settle from this week.  I’m still trying to walk that line between staying invested while times are good and not overextending myself late in a long stretch without a losing week.  I don’t mind running above 100% invested based on my short puts as long as I have a good bit of my positions hedged.  I’m barely over 100% invested now (not counting hedges) and my downside risk is very limited (counting hedges).  I think I could stomach another $30,000 invested on top of what I have already.  My IWM and MDY positions only have two weeks left, so that’ll free up even more cash to work with by the time I need it.

DIA Risk/Reward Breakdown:

  • Potential profit: $394.39
  • Money at risk: $405.61
  • Potential put spread return: 97.23%, 68.0% per month
  • Upside potential based on cash reserves: 1.41%, Annualized: 11.81%
  • Downside cushion: no cushion, need a gain of 0.19% to break even at $140.04
  • Downside risk based on value of underlying if assigned: 1.45%
  • Timing remaining before expiration: 6.2 weeks
  • Position close goal/limit: I’m aiming for full profit.  I’ll let it play out until the final week before the contracts expire.  I’ll probably take the assignment and sell my long puts for a profit if I think the downside is limited from there.