I had a busy day yesterday and took some time after the market closed to rethink some of my positions and planned next moves. I stuck with my idea to give it a couple of days before adding more exposure after my flurry of trades yesterday, but came back to another idea I had been debating on TLT. I was planning to buy my short shares of TLT back with a limit order at $127.70, but had thought about selling puts on TLT instead. I came back to that line of thinking, canceled my limit order to buy my shares back and entered a limit order to sell covered puts on TLT.
While TLT was trading at $128.66, I sold seven TLT March $127 covered puts and received $942.03 after paying $2.97 in commission. When I was debating if I should just buy the shares and cover my short position versus selling puts, I considered strikes from $125 to $130. The $125 puts would give me a lot more potential profit when TLT collapses, but the premium was only around $0.70 per contract and I wanted more up-front to help alleviate some of my upside risk. I probably could’ve earned $3.00 or so from the $130 puts and had even more leeway on another TLT spike, but I still believe TLT will head south soon and I wanted to push for a little more ($945) of a gain.
Selling the $127 strikes gave me a good premium to pocket if the shares aren’t assigned and also gave me solid room to profit further on the next dip. While picking puts to sell, I also considered buying out of the money calls to protect against another drop in yield and further strength in TLT. I might come back to that idea if TLT pushes above $130-131, but I want to wait it out for now.
When these shares were assigned on the final day of January, I figured someone on the other end of the trade was triggering the assignment to have ownership in time to get the dividend. I checked my account over the next couple of days, but didn’t see that I had paid any dividends out. I looked back this morning and saw that I paid $195.31 ($0.279 per share) on February 6. This payout reduces my profit and the same thing happens again on Monday when TLT goes ex-dividend again.
Mainly because of this dividend, but also for quicker time value erosion, I went with the March puts. I can make more money by only selling one month out and since TLT is so volatile, I want to be able to exit early if I decide to and benefit from the quicker reduction in theta (time value).
The last time I made a similar trade a couple of years ago, I was asked why I called these covered puts. I’ll give an easy explanation up front so you don’t have to email me. If you sell calls without owning the underlying stock (or ETF), they are referred to as naked calls. This is the same if you sell a put without being short the underlying stock, which is what I usually do, sell naked puts. If you own shares and sell calls on those shares, they are referred to as covered calls. Again, the same for puts – when you’ve shorted shares and sell puts on those shares, they are referred to as covered puts. The short puts, if assigned, will cover the short shares and the shares will be bought and therefore cover your position.
I won’t bother to write up my usual risk/reward breakdown since the short shares create a completely different dynamic. I don’t actually have a cost to these shares and don’t have any cash that I need to set aside to keep this position alive. If I was simply selling naked puts on TLT, the annualized return would be 17.78% for this trade, but I’ll also profit from the fall of TLT, so that return is only for the premiums. I could consider that I might lose $4,739 (based on original premiums received so far and my short at $130) if TLT runs back up to its all-time high and I buy my shares back then in a silly panic. Using a potential cost of $4,739 and a potential profit of $3,311, I could make a 69.8% return on this trade, not even annualized. The trade clearly has risks, but I like my probability of a profit.