I just got back in town yesterday after taking a few days off for vacation. (I highly recommend a day at LegoLand Florida if you have a 9-year old son, just get there at the open.) I set-up all of my limit orders to expire before I left my office. I didn’t want something big to hit while I was away and not able to adjust as quickly (and write about it). I changed that this afternoon when I saw the market was falling below where it was at the end of last week. The market is far overdue for a solid 5% correction and because it’s overdue, we could see that turn into 7-10%. Anything beyond 5% will be viewed as a buying opportunity for many.
I’ve been planning to open up much more bullish positions whenever such a dip occurred, but I’ve missed more upside potential while leaving cash available on the sidelines. I’ve been a victim of thinking too short-term and not paying attention to my own prediction of a full year SPX return of 10%. Today’s little dip in prices gave me the opportunity to change my approach slightly. While SSO was trading at $72.06, I sold two SSO May $66 naked puts for $0.90 each and received $179.22 after paying $0.78 in commission. The bid/ask spread was $0.85/0.88 when I placed the limit order, good-til-cancelled. I didn’t actually think it would hit today and thought we might see another small drop tomorrow morning that would trigger the order. I was quickly wrong.
The S&P 500 fell another eight points on top of 11 it was down when I placed the order and then recovered a few by the close. My order triggered during the descent on the leveraged ETF and showed me I should’ve stuck with my original plan to sell the puts at $0.95. By the time I started writing this, the bid/ask on this contract was up to $1.02/1.03 and went even higher before cooling a couple of cents by the close. Admittedly, I just lost patience with my lack of May contracts and little upside potential in my portfolio. That doesn’t mean I consider this a bad trade or have seller’s remorse. I just could’ve made another $10 on the sale, but I still would’ve made the same trade. I didn’t stick with the $0.95 that I started with because the difference was so small on an annualized basis and I didn’t want to miss the trade like I had with other recent orders.
I have 1.35% upside on the $13,020.78 I have at risk. That’s only 10.8% annualized, but I have a cushion of 11.6% from the recent high and 9.65% from the price when I made the trade. My goal was to put myself in a position that would allow me some upside if the S&P 500 (SPX) traded sideways, moved higher or fell 5% in a mini-correction. That’s what I’ve done. Considering SSO is a leveraged ETF that attempts to trade with twice the daily movement of the SPX, the large cap index can fall 5.8% (maybe less) before this contract results in the assignment of 200 shares. It’s essentially like I’m getting paid to leave a limit order in place to buy SSO after the type of correction I’m expecting. If SSO falls and I’m assigned, that’s the range I’d like to buy it to catch the ride back up to a 10% return for the SPX. If I didn’t write these puts, I’d probably talk myself out of buying SSO when the markets were selling-off. This trade helps to take the emotion out of my future trade. The part left up to emotion (assuming I don’t close the position early) will be at what strike I sell covered calls if assigned. I expect SSO to finish 2013 above $72.00, well above my strike.
I almost went with a lower strike to give me a bigger buffer before assignment, but I went with the $66 strike to increase my chance of assignment and to get a better return in the meantime. The delta on the put was 0.1908 when I made the trade. That shows a low probability of assignment. I think it’s higher than that considering how long it has been without the market correcting 5%. Just because most years have multiple 5% corrections doesn’t mean this year will behave the same way, but eventually it’ll happen and I’ll keep repeating trades like this until it does and maybe for a while after. Since a 5% correction could quickly turn into a 10-15% decline, I’m keeping this as a small portion of my account, even including the other SSO June $67 put I’m short.