Sold IWM March Put Spread

I mentioned in a post at the end of last week that I planned to get back into IWM today.  I almost decided not to since the small-cap ETF continued to climb and appeared ready to correct.  Then I opted to change my approach and allow room for a correction or a continued small rally.  To do that, I had to sell put spreads in the money.  While IWM was trading at $92.17, I sold three IWM March $94 puts for $2.27 each and bought three IWM March $91 puts for $.87 each.  I received $415.38 after paying $4.62 in commission.

This helps build on my small allocation for contracts expiring in March.  The only other positions I have for March expiration are a DIA put spread that’s still in the money and a SPY naked put that’s out of the money by 2%.  I still have a lot more cash on the sideline that has to be put to work and the more I look at my choices, the more I think I will need to use put spreads in the near-term.

I thought about selling naked puts on this before switching plans, but the downside risk was bigger than this trade’s risk and the upside potential was smaller.  Once I realized that, the decision was easy.  I don’t want to make the same mistake I’ve done in the past and lose money on naked puts when I should’ve hedged or stayed in cash.   The only negative is that I need IWM to gain some more ground before I take a full profit versus having a little buffer with the naked put.  I don’t think IWM will be within 2% of today’s price by the middle of March, so this should serve me better in either direction.

I also chose March for this put spread to expire because it was priced within a penny or two of the April contracts, but had less than half the time value.  That means my annualized return is better with the shorter duration contracts.  In addition, I know we’re going to get a correction eventually.  However, I don’t know if it is a day away, four weeks away or three months away.  I increase my probability of a profit by running this trade on a shorter time horizon in this case due to the extended duration of this run without a step backward.  In other words, every additional week the market moves higher without a step backward increases the probability of a correction coming sooner and likely with a decline that’s bigger.

IWM Risk/Reward Breakdown:

  • Potential profit: $462.62
  • Money at risk: $484.62
  • Potential put spread return: 85.71%, 95.2% per month
  • Upside potential based on cash reserves: 1.49%%, Annualized: 19.93%
  • Downside cushion: no cushion, need a gain of 0.48% to break even at $92.62
  • Downside risk based on value of underlying if assigned: 1.74%
  • Timing remaining before expiration: 3.9 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.  If small caps look vulnerable to further weakness, I’ll close the full position within the final couple of days of the contract.

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