How do you decide on the value of your OTM safety cushion (for instance, does it vary as a function of the time left to expiration?)?
I base it mostly on tech support. Mostly the 2 year chart. Sometimes the 5. If the stock is trading at 25, and there seems to be some support there, per the 1 - 2 year chart, I'll then generally select the area of tech support below it, that pays in the 13 - 20% range. (Depends where I see the best strength of support.) It may also vary depending on the sector it's in, length of contract, how leveraged the portfolio is, whether earnings are pending, whether most of my other trades are currently deep otm or only mildly otm, or ITM, and so on.... Each trade gets evaluated based on it's own merits, and the status of my overall portfolio at that time. I don't have a strict standard. Depending on the stock, the sector it's in, and other variables, the otm % I select could be as narrow as 3 - 5%, or as deep as 25% otm. I once posted a trade of "K", which I believe was trading ATM. Perhaps even slightly ITM. That was probably on Ryan's "My Option Trade" thread, as it was a while back.
What is the typical longest expiration period for which you have been able to find trades that satisfy your minimum return requirement? Could the ATM puts serve as a good benchmark for the OTM short put returns? Were the annualized returns of short ATM puts (when successful) in the range of 35% to 50%?
My trades generally last 1 - 3 months. If I'm going longer it's not to get a higher % return. It's to get a lower strike and a subsequent higher probability trade outcome. I rarely attempt to earn more than 25 - 30% annualized. If a trade offers more I'll generally select an even lower strike. I've generally kept my % returns in the 13 - 30% range over the years. When the VIX is low 13 - 18%, and when the VIX is high 18 - 25%. The only time I'll intentionally attempt to earn a higher % return than 25 - 30%, is when I close successful trades weeks or months early. I've posted a number of those over the past several months. As a general rule, I'm less focused on a trades potential for a profit, and more focused it's "probability" for a profit. Potential vs Probability..... we all have our preferences. You seem very curious about my strategy and goals lately?
I became aware of your posts only recently. I like to analyze things and think about things, and read about how others analyze and think about the same thing. I find it interesting that the same thing can be looked at in a number of ways, and have different variants and implementations. A point related to your entries, I have some models that estimate turning points, and I paid attention to a couple of your stocks to try to see where the models would say a turning point would be. In relation to the returns, my intuition tells me that if one raises expiration time, for the same implied volty (say 35%), one may not be able to find a return higher than a given minimum number. One way I look at selling OTM puts is that one sells a conceptual variance/conceptual volty which encasaptulate OTMness and implied volty. The conceptual variance can vary as a function of time, strike, and implied volty.
I don't look for turning points. I look for stability points. I feel if I can determine an approximate stability point, the turning point will take care of itself. That being, bargain hunters, value investors, and the smart money will eventually see what I see. They will then be followed by the trend followers. That's when I get to close my trade early. Or if they don't see what I see, then I get to hold the trade until exp... or perhaps buy the stock. I agree that most times, I'm not able to get a higher % return by going for a longer exp. Hence the reason most of my trades run 4 - 10 weeks, vs 3 - 4 months. However, there are occasional times that does occur, or it"s a similar %. Perhaps it's related to when earnings are expected to come out, or that they recently just came out.??? There are times I will go for a longer contract, even though there is no added benefit such as a higher % return. WHY? If I really like the stability of the stocks fundamentals and it's currently trading at a strong area of tech support, which I don't think will stay there for long, and doubt the stock will test that area again for a long time,... then I may want to lock in that credit and "higher dollar amount", for a longer period while I can. Particularly if I'm having a hard time finding stocks, strikes and credits I like. During those difficult times, my focus is more on putting my money to work than in optimizing my annualized % returns. There are times "dollars generated" become more relevant than % returns generated. If the drop in % return is huge, that's one thing. But if the % drop is not that big, then it may be worth initiating a longer contract to lock in a "higher dollar amount",... if I think it's a pretty solid trade that I may not get a 2nd chance at again for a long while, and I'm having difficulty finding trades I like. Besides, I can always "potentially" close the longer trade early, if I'm correct and the stock rises. I've posted several trades that I've closed early, keeping 70 - 90% of the credit. Bottom line.... sometimes you have to be flexible. What may" intially" appear to be a longer and thus not as good a % return trade, could end up being a better trade in terms of dollars, credits, and % return, per unit of time.... via an early buy back. However, you gotta pick the right stocks, strikes, credits, and timing of the trade, for a longer contract to work out better than a shorter one. And again,... if the % drop of the longer contract is relatively small, there are times it may be wise to switch your focus from % return to dollars earned. Particularly during periods when it's difficult to find trades you like, and your siitting in cash earning nothing.
Sold puts on $40 WCG for March. Credit $1.35 Annualized % return....... 14% 5 yr chart below: otm safety cushion...13% http://finance.yahoo.com/q/bc?s=WCG&t=5y&l=on&z=l&q=b&c= This is a financially healthy company, and is also very reasonably valued at my strike of $40, with a BE price of $38.65. If the $40 area is broken, the next support is in the $35 area. (I like it when the next support is reasonably close.) 2 yr chart below: http://finance.yahoo.com/q/bc?s=WCG&t=2y&l=on&z=l&q=b&c= I'm trading the March contract, because the Jan credit results in too low a % return, (9.6%) for a $0.35 credit. However, will consider the Jan contract if the stock keeps dropping, and offers a higher credit. I'm currently being paid $0.45 "per month" for the March contract, vs $0.35 per month for the Jan.
How would you rate/evaluate/assess/etc your understanding of volatility ( in absolute scale or in comparison to your understanding of other fundamentals related to short put trading)?
1. Goog says Jan traded at $0.45. If it were possible to have 0.45 for Jan, which of the two trades (Jan vs. March) would have been better at strike 40? 2. If there was a strike at 41, Jan would have been priced at 0.56 if one assumes $0.35 as put price at strike 40. Which trade would have been a better trade: the march 40 strike or the 41 Jan strike, and why?
WCG did trade at $0.45 today. However, at the time my trade was initiated, the the bid/ask was 30/45. Unlikely that I would get filled on the ask. I will assume it was filled at $0.45 either when the stock traded at $46.11, and/or when someone closed a trade at the ask. I believe the stock was trading in the 46.20 - $46.30 area at the time my trade was filled. It had already tested $46.11 before I noticed the stock. I was the only March vol today, so if you are curious, you can check out the exact time my trade was filled and where the stock was trading. If I could have gotten $0.45, I would have taken the Jan. All I can tell you is, eveytime I looked at the stock trading in the $46.20 - 46.35 area, the bid ask was $0.30 - $0.45 for Jan. Would I have accepted a credit of $0.40??? No. An 11% return is too low. My benchmark is 13 - 19% with few exceptions. If given the choice of a Jan 41 with credit $0.56 or my March $40 with credit $1.35.... I would have done the $41 Jan trade. WHY? The $41 strike is still technically reasonable, per the 2 - 5 year chart (BE $40.44), it's also still a reasonable price value, the contract ends "BEFORE" earnings are released in mid Feb, and it would have offered a higher annualized % return than my March trade.