Selling Puts: How to Calculate Return When Selecting Strike Price/Date? And With Margin?

Discussion in 'Options' started by RichLyons, Mar 7, 2018.

  1. spindr0

    spindr0

    Stop with the trick questions :D

    Selling covered calls is very safe (for the broker) and selling short puts can lead to disaster. Well, at least the way they present it out there.
     
    #11     Mar 8, 2018
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  2. spindr0

    spindr0

    You select a strike to sell based on your outlook for the stock rather than looking at a sliding scale of potential returns and picking a happy number. Be that as it may...

    The problem with calculating return from selling short options is the cost basis. The highest number will be based on option margin requirements (approx 20%) but that's really not cash at risk since if it hits the fans, the loss could be more.

    I would start with cash secured. If XYZ is $52 and you sell a one month $52 put for $2 then your cost basis is $50 and ROI is 4%. If done on 50% margin (equity borrowing) then it's double (ignoring borrow costs). If based on option margin, it's approx 20%.

    Once you decide on your cost basis approach, the rest is a simple spreadsheet.
     
    #12     Mar 8, 2018
  3. spindr0

    spindr0

    :thumbsdown: o_O :vomit:
     
    #13     Mar 8, 2018
  4. This question is only complicated because your criteria contain variables. In essence your return is calculated after the fact as follows:

    net profit/loss
    ============== x 100= P% profit
    Capital Employed

    Now your Capital Employed depends on:

    1) Your margin arrangements with your broker
    2) The movement of the underlying as this almost always affects how much capital you need to employ

    In the abstract to answer your question we need the details to the above. The first point is easy enough to figure out but the second one is not so easy. The very best way to come to a conclusion on that is a full Monte Carlo statistical analysis that looks at a thousand different scenarios distributed along a logical curve of probability and then examined under positive, negative and neutral scenarios. This requires more computing power and models than random humans are able field. Furthermore the influence of movements of the underlying is in any case limited (on an upswing it is even zero) so there is no point in overkill here.

    Now here we can use the short-cut that statistics gives us. In the given period X we can calculate fairly easy 3 standard deviations of price upwards and downwards. That gives us 99.7% of all outcomes - this isn't perfect because every year that will be on average one event outside of the balance of these probabilities. This can of course be balanced out by buying a put below the -3SD level but that impacts profits/loss.

    For your sold put scenario its fairly easy to see what could be done

    M1=margin required if underlying moves 1SD within time period X
    M2=margin required if underlying moves 2SD within time period X
    M3=margin required if underlying moves 3SD within time period X

    A reasonable calculation (with 0.3% error) is that your average margin requirement M=[(M1x68%+M2x27%+M3x0.3%)+M1]/2

    A similar calculation can be done on the net profit you expect to get out Pr=premium sold, U2=-2SD of underlying and U3=-3SD of underlying:

    Expected net profit/loss=[(Prx68%+U2x27%+U3x0.3%)+Pr]/2

    In a spreadsheet this is quite easy to input - its not perfect but gets you close to answering your question because you know your desired profit and if you know the price of the underlying and volatility you can determine what the Premium sold is that is required.

    Alternatively again you use: http://www.optionsprofitcalculator.com/calculator/short-put.html

    Which uses a different approach and takes the return as the maximum cost in case the stock goes to near zero.
     
    #14     Mar 8, 2018
  5. ET180

    ET180

    Not sure what you mean lindq. How is my statement wrong?
     
    #15     Mar 9, 2018

  6. But isn't it a 100% true statement, and the problem people get into, is rather than comparing the selling of 1 put or the purchase of 100 shares, they compare selling 5 puts or 20 puts to selling the 100 shares? And hence they become was over leveraged, and then end up on a park bench?
     
    #16     Mar 9, 2018
  7. lindq

    lindq

    Among many issues with shorting puts, the main problem is that in theory it can appear to make sense if one wants to own the underlying and is ready, willing and able to accept it.

    But theoretical gives way to reality when after writing the put the underlying, for reasons that can't be foreseen, crashes and burns, and you are left with an instrument in your account that you would have never bought given the present circumstances.

    Thus, what you are doing in writing the option is assuming/hoping that circumstances at X date in the future are such that you'll be a happy puppy. And that very often is not the case when the shit hits the fan.
     
    #17     Mar 9, 2018
  8. spindr0

    spindr0

    Your statement is correct. The short put seller will always lose less than the outright buyer of the underlying. Lindq's explanation is diversion to convince you otherwise.
     
    #18     Mar 9, 2018
    ET180 likes this.
  9. @lindq What you are saying is applicable to quasi any strategy. If the shit hits the fan for your particular strategy things do not end well.

    In any case shorting puts is done for quite different reasons than wanting to own the underlying.
     
    #19     Mar 9, 2018
  10. ET180

    ET180

    I do sometimes short puts to try to get into the underlying at a better price. A lot of times I short them during earnings when I'm just trying to capture the premium, but often, I do want to own the underlying.

    Yes, it's possible that one shorts a put, then the underlying drops and they wish they had not done that. But that's still better than the situation where one buys the equivalent number of shares of stock, then the stock drops and the buyer regrets the decision to purchase. The second situation is always worst than the first because the put seller will at least get the premium to partially offset the loss.
     
    #20     Mar 9, 2018
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