Coming into today, I had options on four different UWM July strikes, three of them short and one long as a hedge. I was long two UWM July $75 puts and still am. I was short two UWM July $70, $71 and $77 puts. I kept the $71 and $77 naked puts, but rolled the cheapest. While UWM was trading at $84.19, I bought to close two UWM July $70 puts for $0.61 each and sold two UWM October $75 puts for $4.11 each. I received $698.32 after paying only $1.68 in commission on the four contracts traded.
This was a fairly easy decision to make this trade, but it took a few days for my limit order to hit. My July $70 puts were getting relatively cheap with more than a month to go before they expired and the upside I had was very limited with so much time decay already gone. I saw an opportunity to exit a cheaper position and enter a new position without changing my downside risk by much, but doubling my upside potential. There’s not much to debate when a trader’s choices are between making more money or not. I gave up a cushion of 17.57% for a cushion of 15.79% and am missing out on a potential gain of 0.87% for a potential gain of 5.79% (8.41% and 16.37% annualized respectfully).
The risk comes from the time until expiration. While the economy seems to be improving based on the majority of the data coming out, a lot can change with more than 18 weeks before expiration. Political input, be it domestic or international could play in. We’ll see two more earnings seasons before these new puts expire. We have four more employment data reports and four or five more reports from most other data sources too. Still, I don’t see this as a highly risky trade because I have a sizable cushion that offers an adjusted price per share if assigned that is lower than where support came into play in the May low point.
I still have two long puts to cover some of my losses if a bigger than expected slide hits soon. I might find that I could’ve made more money by waiting for some retracement after the small-cap’s huge rally over the past few weeks. However, I’ve learned it’s better to make a good trade when you can than be greedy and hope for better later. Either way, I still have the other UWM July puts I can roll out on further small-cap weakness if I want to stick with the leveraged ETF. I might move back to IWM instead of UWM when I close my next July UWM puts. I’m not sure yet since I don’t see a new big wave of selling hitting small-caps over the next few months. I think they’ve had their correction, at least through October.
UWM Naked Put Risk/Reward Breakdown
- Potential profit: $821.15
- Potential return: 5.79%, 16.37% annualized
- Breakeven price: $70.89
- Downside protection: 15.79%
- Recent high: $87.06 on May 9 and $92.46 on March 4
- Cushion from the all-time high in March: 23.32%
- Expected support: $83 and just below it will be interesting to watch. The 10-day moving average and the 100-day moving average could both slow or stop a slide. A short trend line of higher lows is approaching that area too. The next cluster of moving averages shows around $80.00 (+-$0.50) where the 20, 50 and 200-day moving averages could bring in the buyers. A break below the 200-day moving average could bring a slew of sell orders from the algorithms, but support could be as close as the previous June low of $78.17. If all else fails, I’m looking for strong support at the May low of $73.17, $2.28 above my break-even price.
- Position close goal/limit: I’d like to find an early opportunity to roll these naked puts out like I did with the July $70 puts that I bought back today. I think I have a good probability of that working for me since the strike is so far out-of-the-money right now. If not, I’m willing to hold onto these puts and risk an assignment because I don’t think the selling will go below $75.00 very far or for very long.
As 70 strike is well below the current underlying, isn’t it better to let the option expire and roll only if the trend reverses?
Martin,
That’s how I used to handle options that were far OTM, but once the trend reverses, the price can spike for the option and makes it a more expensive buy-back. I still work it that way sometimes, but have moved to a more conservative approach.
It can be more profitable to let the time value erode on its own, but only if the trend doesn’t reverse. In the past, the vast majority of the options I left to expire finished OTM, but the few that went against me cost me much more than I saved by not buying the others back. The risk is much greater on leveraged ETFs like this one. I don’t really think UWM will fall that deep, but the risk isn’t worth the chance. If I wasn’t replacing this option with another one I would’ve been more likely to leave it in play until expiration. I didn’t need both contracts open and the new one has a better profit potential, so I swapped them.