I started playing with this order yesterday, but didn’t want to move my SSO put strikes higher until the rally took at least one step backward. The S&P 500 had moved higher for nearly two weeks and volatility plummeted during that rise. The trend took a break today. Although my SSO December $78 and $80 puts are nearly two full months from expiration, they both have become fairly cheap and have little upside remaining. Rather than flipping everything on a single day’s weakness, I only rolled my two $78 strike puts today.
While SSO was trading at $90.86, I bought to close my two SSO December $78 naked puts for $0.76 each and at the same time sold two SSO December $85 naked puts for $2.57 each. I received $358.92 after paying $3.08 in commission. I sold the December puts just over two months ago. So, I took a $485.40 realized gain (after commission), or 76% of the original premium, in a little more than half of the planned life of the trade. This early exit improved my annualized gain a good bit. This ability to roll puts early for a larger percentage of the profit than expected comes from multiple inputs including the outsized gains in the S&P 500, a drop in volatility and the fact that I started so far out-of-the-money that the probability of assignment sank significantly.
I made the trade because I don’t think the S&P will correct much more than 5% if it even gets close to that before expiration, but I’m not convinced there is a lot of upside in the near-term either. The $78 strike puts gave me a 16.5% cushion from the recent high, which is around 8.25% of downside for the S&P 500. The January $85 puts give me a 10.89% cushion, or almost 5.5% for the S&P 500. Because SSO is a “2x” leveraged ETF, I don’t like to sell naked puts close-to-the-money unless I’m highly confident in the market’s direction for the next few months. After such a great run this year, I don’t have nearly that much confidence. While I think the index won’t fall much, I’m comfortable with the idea that if we get an 11% correction, I’ll only be down 11% too. After the initial 11% (really 10.89%), I’ll start losing 2% for every 1% that stocks lose. I don’t see that as much of a possibility, but something could always pop up.
The upside difference was even greater. I moved from a 0.96% possible gain to a 3.01% possible gain. On an annualized basis, including the added time to the new contracts, I moved from 5.9% to 12.5% annualized. In years past, I never would’ve considered buying back an option for as much as $0.76, but I’ve learned the benefit of removing small risks to increase profits. I could end up regretting cutting my buffer from a loss, but the gains from repeating this roll higher on a regular basis tends to outweigh the infrequent losses.
The change in delta was smaller than I thought it might be. The December $78 puts had a delta of -0.1121 and the January $85 puts had a delta of -0.2865 around the time I made the trade. The delta on the position more than doubled, but it’s still fairly low since it’s so far out-of-the-money.
SSO Naked Put Risk/Reward Breakdown
- Potential profit: $512.46
- Potential return: 3.01%, 12.5% annualized
- Breakeven price: $82.44
- Downside protection: 9.27% (equal to about 4.6% on S&P 500)
- Recent high: $92.51 on 10/22/13 (yesterday)
- Cushion from recent high: 10.89% (equal to about 5.45% on S&P 500)
- Expected support: $89 at the 10-day simple moving average (sma), then $87 at the 20-sma, then $85 at the 50-sma and a trend line of higher lows. It’s possible SSO could correct down to $83.71 at its Fibonacci 23.6% area as it has on recent mini-corrections. A drop this low would put it close to its 100-sma and would still be a profit for me.
- Position close goal/limit: If I can’t roll it early for a good profit, I plan to stick with it through expiration and take assignment for long-term hold. My cost should be low enough that I can manage the position with covered calls if I have to use patience.
I mentioned my SSO December $80 puts at the top of this summary. I’m leaving them in place for a few more days to see how prices move. I’m planning to roll those puts before expiration also, but don’t want to rush into it if I can get a better price by waiting a few days or a couple of weeks. I didn’t want to wait on the $78 strike puts in case this is simply a one day dip.
To get roughly the same dollar and percentage gains using the non-leveraged ETF SPY, I would have only had a 3.0% buffer from a loss from yesterday’s all-time high. Since I think we could get a dip greater than 3%, but not more than 5-7%, I view the SSO trade as having a lower risk, even with the leveraged risk included. I like the idea of the SPX falling 5% and my trade still finishing with a 3% gain.