I wasn’t planning for this trade to hit today when I entered it. My plan was to get an order in place to hit on any weakness over the next week. That weakness took about an hour to surface instead of a few days. I was in the process of changing a client’s position to roll IWM puts to July from May and figured I could do well on the July portion of that trade in my account too, if IWM came back to this morning’s lows and the contract’s highs.
While IWM was trading at $95.96, I sold three IWM July $95 naked puts for $2.85 and received $853.82 after paying $1.18 in commission. When I started looking at the trade, the contract was bouncing between $2.60 and $2.65. I checked the high trade of the day and saw it hit $2.85 at some point. That’s not a completely reliable indicator of how high the contract’s bid/ask got during the day, because it’s possible that no trade hit when the contact had a higher bid/ask. The way the market was behaving in the afternoon, I thought the worst was over for the day and figured the tomorrow morning would be my first real opportunity for it to hit.
This is a little bit more aggressive of a trade than some of what I’ve been doing lately and I’m already nervous about it. I’m expecting a little retracement from the recent bump higher, but don’t think it’ll go too deep. I noted a couple of my expected support levels in the section below. Those levels of expected support are what I based this trade on. I won’t be surprised if this contract finishes in-the-money, but I will be surprised if I lose money on it. Even on a dip, I’m not expecting it to last very long. That can all change if we get a shock from the Fed on interest rates or some other external factor pops up.
Small caps will fall quicker than large caps in most scenarios and I’ll pay the price for it, literally. I’m expecting no more than 5-6% to the downside in large cap stocks and probably no more than 7-8% in small caps. A drop of 7.78% from the recent IWM high would put the ETF around $89, which is where it bottomed in April. I’d be down close to $950 on paper with IWM at $89 and would have a lot of upside potential from there. That’s partly the way I’m viewing this risk/reward. I stand to make $853.82 and don’t think I have a high probability of losing more than $950. That’s not a bad risk/reward set-up in a bull market.
IWM Naked Put Risk/Reward Breakdown
- Potential profit: $853.82
- Potential return: 3.09%, 15.7% annualized
- Breakeven price: $92.16
- Downside protection: 3.96%
- Recent high: $96.51
- Cushion from recent high: 4.51%
- Expected support: Above $92.50, if not the May 3rd low of $94.36
- Position close goal/limit: Plan to stick with it through expiration and take assignment for long-term hold. If I see a real change in sentiment, I might cut losses quickly or add a hedge. Depending on how the next few days go, I might buy a vertical put farther out-of-the-money to cut my pain on a bigger sell-off.
My June and July expirations are looking good for cash flow. I might cut some of that exposure sooner than later. My account balance is back over $110k and I’d like it to stay up there. I don’t have any other May options and might be wise to reduce my risk some by taking some profits this month instead of next.