What a difference a week can make! Coming into this week, I had one option remaining to expire in December. My lone MDY $265 put was deep in the money as MDY closed last Friday at$255.71. I would’ve had a loss on the option contact if I had bought it back at the time. I remained patient with the idea that the market was only in the middle of a small profit-taking period and better days were ahead. I didn’t expect the massive reversal that we had on Wednesday and Thursday, but it certainly worked in my favor.
MDY made it up to $263.60 just before the close yesterday and then lost some of that this morning after the ETF went ex-dividend today with a $1.0741 dividend. Rather than take the assignment on my naked put, I decided to roll it out to March. While MDY was trading at $263.15, I bought to close one MDY December $265 put for $2.06 and sold to open one MDY December $265 put for $10.16. I received $809.30 after paying $0.70 in commission, $0.34 to close and $0.36 to open.
MDY was trading at $258.91 when I sold this December put in mid-September. So, I did the right thing by selling it in the money and was able to earn both intrinsic value and extrinsic value while I was short the position. I wasn’t able to get a full profit on my naked put, but was able to earn a realized gain of $971.29, better than the $424 I would’ve made by using a buy and hold approach. In fact, I even when I factor in the taxes I’ll have to pay in April, I did better than buy and hold. This is another great example of why I continue to trade options. I reduced my risk during the time I was in the trade and made more money on top of it. That’s the best of both worlds!
Briefly, I thought about selling the January contract, but it didn’t offer nearly as much cushion as the next available contacts in March. I decided to keep my strike the same to allow for more upside potential. I considered the $270 contract too, but the $265 gave me an extra $2.00 for my breakeven cost and I decided to go with the safer route. The percentage difference wasn’t that much and I might regret not pushing for more, but the annualized return on the $265 put I sold is good enough without getting greedy.
Looking back at previous two trades I’ve made on MDY, I realized that this is the third time I sold the $265 strike. In June, when I sold the first $265 naked put, MDY was trading at $258.78. I’ve made money on the option in both of my first two attempts. Now I have to hope that I can make it a hat trick.
MDY Naked Put Risk/Reward Breakdown
- Potential profit: $1,015.64
- Potential return: 3.99%, 15.70% annualized
- Breakeven price: $254.84
- Downside protection: 2.91%
- Recent high: $265.94, hit on November 25, 2014
- Cushion from recent high: 4.17%
- Expected support: I wouldn’t be shocked if MDY fell some to “fill the gap” from its jump higher yesterday. A dip like this would only bring the ETF down to around $259-261 and allow it to stay above its 10-day moving average. If the simple retracement doesn’t satisfy the bears, we could see MDY move down to its ascending 50-day moving average, currently at $256.03 and climbing quickly. I don’t expect a real correction to hit within the next month and a half, but after January, things could get tricky again. The lowest I expect MDY to trade before the end of January is a retest of its December low, $251.93, touched four days ago.
- Position close goal/limit: I consider MDY one of my core positions and am willing to take an assignment on the mid-cap ETF, assuming nothing drastic changes in the macro-economy. Considering that MDY is below its peaks seen on July 1, 2014 and September 3, 2014, it has already spent nearly six months consolidating and should be ready for a push higher again. If not, I’ll weather the storm on weakness.
The next week and a half include Christmas and New Year’s Day. Volume should drop substantially starting on Monday and I might not make more than one more trade for the remainder of the year. I dawned on me the other day that I’m almost due to make my annual withdrawal from this account to start the year with an even $100,000 again. Luckily, my four January UWM options are far out of the money and I’ll be able to close them in early January to stay off potential margin in the event of a black swan event.