Once again, I had a thin day for closing positions on option expiration day. The only option I had remaining coming into today was one SPY February $185 naked put. It was in-the-money by $0.90 after yesterday’s close and started today by gaining ground up to $184.89 before rolling over and closing at $183.92. I waited until the afternoon to roll it out to April. The February contract had as much as $0.25 in time value this morning and I saw no reason to buy back the position early in the day when I could wait until later in the afternoon and let time decay help me.
By the time the Theta (time value) fell to $0.15, I started pricing diagonal put spreads. I couldn’t have played the February contract any better up until today. Back in November, I sold the put in-the-money by $3.91 and since then SPY gained a lot of that value back. This was much better than using a buy-and-hold plan because I gained the extra $280 of time value on top of the growth in the underlying ETF.
While SPY was trading at $183.99, I bought to close one SPY February $185 put for $1.03 and sold one SPY April $186 put for $4.83 and received $378.59 after paying $1.41 in commission. I left only $0.02 in time value on the February put, but could’ve done better by making my trade when there was $0.10 of time value left in the February contract. At that point of the day, the diagonal put spread could’ve gone for $3.95 instead of the $3.80 that I sold it for. I didn’t pull the trigger then because it looked like there was positive momentum building and I thought I could get a trade closer to $4.05 as intrinsic value decreased along with time value vanishing at a faster rate for the February put than for the April put. Instead, intrinsic value increased at a faster rate than the time value on the April put and I missed out on $15.00 that I could’ve made it I traded earlier in the day. The difference amounted to me making a smaller realized gain on the February put (but still a nice profit of $569.59) and a bigger potential gain on the new April put, but at the cost of a smaller cushion than I expected a few hours earlier.
I had the choice of leaving the contract alone and letting the 100 shares be assigned to me. The risk/reward of rolling the expiring put out to another naked put that’s farther out on the calendar versus buying the shares and then selling a covered call is essentially the same, but there’s a different wrinkle to it. The wrinkle comes from the hassle of adjusting trades when it comes to tax season and my desire to avoid extra work.
I started doing my taxes already for last year and noticed that Interactive Brokers (IB) was accounting for option assignments differently than I was. I take the realized gain or loss on every put or call when I buy it back. IB does the same. However, I account for option assignments the same way as I do with positions I close by buying – by taking the realized gain or loss when it happens, but IB doesn’t follow the same method. IB reduces the cost per share of the ETF or stock purchased by the profit received on the put. When a covered call is assigned, the cost per share increases by the amount of profit received from the covered call. Their way is more of a pain, but is the correct way to do it. I’ve known that for years, but always avoided the extra work. My way doesn’t cheat on taxes, it actually is better for me to do it their way since I get to delay capital gains. This year, I’m going to file correctly and I want to avoid the extra headache of having to make these changes to my trades after I download them. I’m sure I’ll still let some naked puts be assigned, but I’d rather avoid it whenever there is an easy alternative, such as rolling the put farther out for a quick realized gain.
Not to beat a dead horse, but here’s an example for those of you who were confused by my rambling above. If I took assignment of these SPY shares at $185, I’d pay $185.00 per share, but for tax purposes, I’d have to update my records by reducing the cost per share by $6.73 per share (because I received $673 when I sold the put). That change would make my cost per share equal $178.27 and my February put not be reported. If none of my covered calls forces an assignment and sale of the shares this year, that $673 profit wouldn’t be recorded as a realized gain this year. All of my unassigned covered calls throughout this year would be recorded and taxed as realized gains this year. If I turn around and sell the shares next year at $185 on a covered call that I sold for $3.50, I wouldn’t be break even on the shares even though I bought and sold the shares for $185.00. I would add $3.50 per share (from the covered call that was assigned) to the sale price and would record a sale price of $188.50. My realized gain next year would be $1,023.00 ((188.50-178.27) x 100 shares). It all adds up the same, but that’s how the IRS would prefer option traders report it for taxes.
SPY Naked Put Risk/Reward Breakdown
- Potential profit: $482.29
- Potential return: 2.66%, 17.1% annualized
- Breakeven price: $181.18
- Downside protection: 1.53% (Need 1.09% gain for full profit)
- Recent high: $184.95 on February 19, two days ago
- Cushion from recent high: 2.04%
- Expected support: $182.65 -around the lows of this week (touched twice); then $180.00 – at the 20-day moving average. The 200-day moving average could come into play down around $178.50 and then I don’t expect the February low around $174 to break final support.
- Position close goal/limit: I’ll roll it early for a good profit if I can, but I don’t expect that to happen. I think SPY will be relatively range bound, which will be good for me again as I pocket the time value and maybe a little intrinsic value from some growth.