I knew it was time to move my June MDY exposure out to a farther month and as I mentioned in my month end summary a few days ago, I planned to move the strike higher too. By the time I got around to placing the order today, the $250 strikes offered a pitiful return. The $255 strikes weren’t too good any longer either, so I sold my new put in-the-money with the expectation that stocks are going to move higher over the next few months. While MDY was trading at $256.28, I bought to close one MDY June $245 naked put for $0.45 and sold one MDY September $260 naked put for $10.30. I received $983.26 after paying $1.74 in commission.
The June MDY put only had 0.18% of upside in it. By selling this diagonal spread (different expiration and different strikes), I lowered my cushion before taking a loss from 4.57% to 2.56% from the price of MDY when I made the trade. This increased risk seemed worthwhile to me since I added nearly 4% more upside potential. Even on an annualized basis, the September put has 10% more upside if it works out for me. I wish I had made the trade earlier in the week when it looked like economic data was coming through mostly positive, but I wanted to wait for today’s jobs’ data. By then, a lot of the risk takers had already driven MDY more than $6.00 higher than its low on Monday. At least I made the trade in the morning because by the end of the day the contract look like it would go for around $9.60 based on the wide bid/ask of $9.00/10.20.
MDY Naked Put Risk/Reward Breakdown
- Potential profit: $1029.12
- Potential return: 4.12%, 14.10% annualized
- Breakeven price: $249.71
- Downside protection: 2.56%
- Recent high: $257.52 (hit about 90 minutes after my trade)
- Cushion from recent high: 3.03%
- Expected support: $252.50 in the next couple of days would be a retest of the sharply ascending trend line of higher lows and the 10-day moving average. $250 is closer to the 20-day moving average and is close to where MDY saw support last week. The longest trend line of higher lows is around $246. I don’t think MDY will fall below it in the near-term.
- Position close goal/limit: I’d like to have the opportunity to close this position by mid-August if MDY has moved above $260.00 by then. I’d like to hold onto it and be willing to take an assignment if it drops as low as $242.50 and anything below that line of support from May will make me reconsider.
This next trade might be more of surprise to some of you since I’ve been fairly risk averse in my individual stock picks for more than a year. However, I think the far out-of-the-money Facebook (FB) options are worth the risk. While FB was trading at $63.08, I sold two FB August $55 naked puts for $1.66 each and received $331.01 after paying $0.99 in commission.
I usually try to avoid stocks with high P/E ratios, but I view FB differently and hope it doesn’t come back to bite me. FB’s trailing P/E ratio is 81.82, but its forward P/E ratio is “only” 34.46 and the PEG is only 1.27. While I could see their growth slow, they have huge cash flow and continue to buy other companies that can help their growth and profitability. They’ll buy some losers, but if a couple of the purchases work out (think of when Google bought YouTube), they could hit another growth streak and have even more cash to work with.
After peaking in March, they got slammed when high P/E stocks in general stopped being in favor. The dust started to settle in April and they’ve been in a sideways trading channel since then. FB broke above its high side of the channel last week and bested that high by $0.05 yesterday. Today it retested its low range from the past two weeks, around its 100-day moving average. I’m not confident that FB is going to take off to new highs any time soon, but I do have a good degree of confidence that it won’t fall below its low range from the past two months.
I might have been wiser to only sell one contract today and come back for another on further weakness or a breakout, but with $8+ between the price of FB when I sold the put and my puts’ strike, I figured the risk of losing any money wasn’t huge. I forgot to note the delta for the option when I made the trade, but four and half hours later, at the end of the day, the delta shows as -0.2258. That’s not tiny, but it’s not a high probability strike by any means. FB is more almost $0.60 lower now than when I made my trade and this put is trading for $0.11 – 0.12 more than when I made my trade. The delta when I made the trade late this morning would’ve been a little less, but not much different.
FB Naked Put Risk/Reward Breakdown
- Potential profit: $331.01
- Potential return: 3.10%, 15.82% annualized
- Breakeven price: $53.34
- Downside protection: 15.43%
- Recent high: $72.58 on March 11, 2014
- Cushion from recent high: 26.50%
- Expected support: I’d like to see $62.00 hold support like it has recently. If it breaks (and it won’t surprise me if it does), $60 could offer good support. If $60 doesn’t hold, I could easily see a retreat down to the lower end of the trading channel, close to $56.50. The low since January 30 was at $54.68, above my cost if assigned. I’m banking on it to hold support again on any serious weakness.
- Position close goal/limit: Something drastic will have to change for me to exit this position early. That’s not out of the question with such a high flier, but FB would have to fall below 6-month lows to make this trade a loser for me. With the strike so far out-of-the-money, there’s a good chance I’ll be able to close this early for a quicker profit if FB stays above $60.00. The next earnings announcement is due around the fourth week of July. I might try to close it before then, but will probably wait for volatility to plummet post-earnings.
Thanks for write-up! I’m just starting to get into options trading and love hearing all the different ideas. From the size of your open contracts I know I don’t have as much capital to work with as you so I’m having to be more frugal with my available buying power.
For the August FB puts, how did you decide on the August date? Wouldn’t theta decay be fastest for something around 30-45 DTE? Do you try to manage your winners at say 50% or so and that reallocate that money to additional contracts?
Thanks for the advice!
Thanks Scott!
I try to balance reward with cushion. I like to get a minimum of a 10-11% annualized return on most index ETF trades. For high P/E ratio stocks, I like to get a better reward since the downside risk is greater. 15% was my target this time and I wanted to have my cost per share lower than $55. The August puts worked out best for those guidelines. The September puts would’ve increased my buffer before a loss, but the annualized return would’ve dropped and the theta decay would’ve been much slower.
I don’t usually target a specific percentage gain for my winners before closing them. I try to get as much gain as possible before I close my naked puts. Lately, I’ve been weighing the returns of my shorter-term expiring puts with the returns of what I could get if I rolled them out further in the calendar. If the return is much better, I’ll roll it sooner than later. Sometimes I just close my options if I can get out cheaply and/or see my annualized return is less than 5%.
Since volatility is so low right now, it’s harder to manage the balance of risk and reward to get as much advantage with selling options as it used to be, when volatility was higher.