Options Expiration – August 2014

Sideways moving markets can be great for option sellers and can be somewhat boring sometimes too.  Option sellers have the advantage of making a profit (or a reduced loss) in a sideways (or slightly down) market if the premiums were traded at the right time and strike.  I haven’t made a trade this month because I wanted to see how the little dip was going to work out.  Now that we seem to be recovering, I know I need to get on the ball and up my exposure.  Luckily, even though I’m not fully invested, I do have a few puts that are in-the-money and give me good upside exposure.

The timing on my two puts that expire today was mixed.  I have one DIS August $82.50 naked put that will expire out-of-the-money since DIS is trading above $89.00 as I write this in the morning.  I should’ve rolled the puts higher last week when the stock moved above its 10 and 20-day moving averages after multiple weeks of moving sideways.  Still, I finish the contract period with a full profit and that’s always a good thing.

My two FEZ August $44 naked puts didn’t work out as smoothly.  FEZ is up again today and has been climbing steadily for a few days, but hasn’t made it back above my strike or even to a paper profit on the options.  FEZ is trading at $40.46 as I write this, up $0.28 on the day.  The Europe ETF is facing resistance at its 20-day moving average and I expect it’ll move higher through the moving average, even if it pauses there briefly.  Rather than closing my position, I’m going to take the option assignment and buy 200 shares of FEZ at $44.00.

Thanks to the premiums I received from selling the puts, my cost per share will be reduced to $41.89.  While that’s still $1.43 below the current price for FEZ, it’s much better than if I had bought FEZ shares for $43.67 (the price of FEZ when I sold these puts).  Looking back on my expected support from May 13, when I sold these puts, nothing I predicted really worked.  The 200-day moving average held support for a couple of weeks, but then the bottom fell out.  As I said then, I don’t mind taking this assignment.  It’s less than 8% of my current account value and probably doesn’t have more than $5.00 more of downside at the worst more likely, not more than $2.00 (5.0%).

Just as I was finishing writing the comments above, about 12 minutes after I noted the price of FEZ moving higher, news came out of military action in Ukraine on Russian forces that had crossed the border.  FEZ nose-dived and a limit order that I entered a few days ago hit.  While FEZ was trading at $39.78, I sold two FEZ September $40 naked puts for $1.00 each and received $198.42 after paying $1.58 in commission.  My logic for this trade was that I wanted to lower my cost per share if FEZ fell further while I was long the shares.  Since I knew I didn’t want to sell covered calls on my FEZ shares yet due to both how cheap the premiums are and my expectation that FEZ is on the rebound, I wanted premiums from somewhere else with the belief that FEZ would trade flat in the worst case.  That theory might not float if Russia keeps pushing on Ukraine, but the markets haven’t run off the rails yet.  Then again, every time I divert my eyes from writing this, it appears the indexes are melting lower.  It’s just not a panic yet.

When I placed my limit order, FEZ was pushing higher.  I placed my order at the ask price, only 10 cents above the bid at the time.  I thought it could hit on a small move lower as part of the ebb and flow of regular daily movements.  At the time, Russia was pulling back and everything was starting to look rosy again.  I figured I could get a quick profit if I kept the duration short, so I went with the September contracts instead of going out to the next ones available in November.  Also, by going shorter-term, I’ll be able to re-write new contracts sooner if these aren’t assigned and have a better annualized gain.  If I am assigned another 200 shares, my cost will be $40.45 and will give me a much better (and quicker) opportunity to turn this position into a profit.  On the downside, I don’t get as much cushion as I would have with the November puts, but the difference wasn’t as much as I would’ve expected for tripling the duration.  What’s crazy is that I just realized this is my first option assignment this year.  Everything else has finished above my strikes or I closed early.

FEZ Naked Put Risk/Reward Breakdown

  • Potential profit: $198.42
  • Potential return: 2.54%, 25.43% annualized
  • Breakeven price: $39.01
  • Downside protection: 1.94%
  • Recent high: $45.26 on 6/19/14
  • Cushion from recent high: 13.81%
  • Expected support: FEZ is already below the three points of support I identified in May and it also hit a new high while I was short those puts.  Let’s hope I’m better predicting support this time.  $38.86 was the low on February 3.  I’d like to see it hold again.  This expectation was my main reason for choosing the strike I sold.  If the February low doesn’t hold support, FEZ could quickly fall to its low on August 30, 2013 of $35.16 and would officially be in a bear market at 22% below its high.
  • Position close goal/limit:  Since I’m working this trade while already being long 200 shares of FEZ, I have the mindset that it would be good to lower my cost per share.  While I’d rather take a full profit on these puts and sell my long shares for a profit, I’m still comfortable taking an assignment of another 200 shares.  An assignment for a total of 400 shares could push my allocation to around 15% of my account value.  Depending on how my other positions have worked through next month, I might consider selling another two puts out-of-the-money on FEZ.  Eventually, the ETF will rebound and with a beta of 1.27, I want to be long when it heads north, even if I mistime a couple of entry points.

« « End of the Month Summary – July 2014 - | - Dropped SPY Hedge & Exchanged AAPL for DIS Puts » »

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  1. Comment by Martin

    Friday’s trading was definitelly interesting as far as the whole market goes. It was intersting seeing DJI swinging 190 points during the day.
    Are you planning on holding FEZ or just get assigned and get out when the price recovers? Not sure if I understood your “Position close/goal” correctly. Also, I am trying to understand why you prefer assignment over rolling the options. Is it because with assigmnemnt you can recover your cash faster (lowering your cost and selling long shares vs. waiting for expiration in another cycle)?

  2. Comment by Alex Fotopoulos

    I’m planning to hold FEZ until the price recovers. I might hold it beyond break-even if I see good momentum working. I’ll probably sell covered calls on it when the $43 or $44 strike calls get richer. In other words, I’m not 100% locked into an exit plan yet. It’ll depend on a few variables. I think FEZ will move substantially higher from here, but I might not push for all of the gains if I can get out and get into something better.

    I don’t see a difference in the risk/reward of taking an assignment and writing covered calls versus rolling the puts to a new expiration. The downside can still go to $0 and the upside has a cap.

    The reason I took the assignment here is because I see more upside soon and don’t want to cap my gains yet. Also, I’m not completely clear on how the wash rule works on option assignments. My (not a tax advisor) understanding is that to take the loss on the first loss, you cannot sell another put in-the-money for the same underlying position because the risk/reward would be considered “substantially similar”.

    A couple of years ago, I spoke to Steve Sears (Barron’s Option Editor) about this and he was careful not to advise on the law so he referred me to his friend at the OCC who sent me their guide, http://www.optionsclearing.com/components/docs/about/publications/taxes_and_investing.pdf. In short, I decided not to push the envelope, even if it’s unlikely the IRS would ever pursue it. If you haven’t read this pdf, I highly recommend it for all option investors. There is probably some wiggle room with different expirations and different strikes, but I’d rather just play it straight and not mess with the risk of being called out in an audit on a wash sale.

    It’s a pain to adjust every cost per share when assigned, but it’s the way the IRS wants you to do it, even if the net total taxable income is the same in the end.

  3. Comment by Naked Options Trader


    Quick question, when you eventually sell covered calls against FEZ does that further reduce your cost basis if they expire OTM? Figuring cost basis and adjusting it has always been an interesting quandary for me and I’d like to get your take on how you handle it.

    And when it comes to FEZ, just wait till this winter when Europe really starts to need Russian energy again and I’m sure FEZ will move back your direction!


  4. Comment by Alex Fotopoulos

    If covered calls are not assigned (i.e. finish OTM), they do not reduce your cost basis for tax purposes. You have to take the short-term gain on the call premiums when they expire. Of course, for my own records (not tax records), I consider it a cost reduction because I have actually reduced my cost. It’s funny numbers because the result is the same in the end, unless you hold the shares long enough to make it a long-term gain or have the position run through into the next year.

    FEZ could get very interesting over the winter.

  5. Comment by Martin

    Yea, that’s a good strategy selling covered calls and further lower the cost base. And FEZ is an ETF where it makes sense to do that. I like it.

  6. Comment by Martin

    That brings another question. Do you ever sell ITM calls as a protection? I wish to do that, but hesitate as that is something you need to be right on direction if you do not want to get assigned.
    It’s probably easier with ETFs than individual stocks.

  7. Comment by Naked Options Trader


    Thanks for the reply. That’s how I track my covered calls as well. I was just curious to see if other prescribed to the same method.


  8. Comment by Alex Fotopoulos

    @ Patrick, no problem. I appreciate the question. I’m sure you weren’t the only one wondering.

    @ Martin, It’s rare for me to sell ITM covered calls. If I’ve been assigned a stock or ETF from a naked put (which is pretty much the only way I would buy a stock/ETF), I would probably think there’s good upside coming. Otherwise, I’d avoid the assignment and take my loss on the naked put. If I think there’s good upside, I wouldn’t want to cap that growth with an ITM CC. From a tax reporting view, it’s a lot easier to take the loss on a put and sell a new OTM naked put rather than an ITM CC. The risk/reward is virtually the same with an OTM naked put and ITM CC, so if I can save a few steps in tax reporting, I’m happy to do it.

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