[Investor237]

Hi Teddi,

Are you still working on the article discussed in your April 8th post?

[Investor237]

Thank you.

[Investor237]

I look forward to reading it once it is completed. Thank you.

[Investor237]

OK. Great. Thank you Teddi for all the work that you do.

[Investor237]

My trade worked out well. I was using the trade as a way to illustrate my concerns.

So, the long put, in a put credit spread, serves as insurance ONLY in the case of a significant collapse.

However, it appears to be of no help if the underlying closes between the short and long strike. Or am I missing something in the equation?

Furthermore, I find that the margin requirements for a put credit spread are misleading. Using my previous example of a short 26 strike and a long 20 strike, the margin requirement (both initial and maintenance) is $600 per spread. However, if at expiration, the underlying closes between the two strikes, my cash requirements suddenly jump to $2600 per spread. Does that mean that whenever one initiates a put credit spread, one must set aside the full cash requirements of the short strike for the entire duration of the position? Is that what you have been doing Teddi? Do you keep enough cash to fully cover the exercise price of every single put credit spread that you initiate? If that is what one needs to do, and if one wants to earn 1% per month, then that 1% needs to be calculated on the total value of the short strike and not on the value of the spread. Option premiums rarely allow for those kinds of returns.

Teddi, your reply brought up two more questions:

1. You recommend that when one initiates a put credit spread, one must be willing to own the underlying shares at that strike. However, in your reply, you indicated that you did not accept exercise of the 45 short strike on WFC, choosing instead to close the short put for a loss and let the long put “ride”. If you were willing to accept assignment when you initiated the trade, why did you not then accept assignment of the short puts at 45?

2. You recommend closing a short put if the loss equals 50% of the profit made on that short puts. In other words, if the premium of the short put rises to equal 150% of the price received, you would buy back the short put. However, I believe that this situation happens on many trades, even if the short strike is not in danger of being violated. That would lead to closing most positions for a loss, even though they were not really in danger and would have been profitable. For example, I initiated a MSFT Apr 3 put credit spread (125/115) on Mar 27 when MSFT was trading at around $152. The short strike was sold for $0.43. Looking at the charts of the past week, MSFT never traded below $149 (very far from the 125 short strike) yet I see that the 125 put options premium was above $0.645 (50% loss) a few times (according to the chart on IB). That would have meant closing a position for a loss, even though it was nowhere close to being in danger. Can you please clarify this point for me?

Thank you for all your input.

[Investor237]

My trade worked out well. I was using the trade as a way to illustrate my concerns.

So, the long put, in a put credit spread, serves as insurance ONLY in the case of a significant collapse.

However, it appears to be of no help if the underlying closes between the short and long strike. Or am I missing something in the equation?

Furthermore, I find that the margin requirements for a put credit spread are misleading. Using my previous example of a short 26 strike and a long 20 strike, the margin requirement (both initial and maintenance) is $600 per spread. However, if at expiration, the underlying closes between the two strikes, my cash requirements suddenly jump to $2600 per spread. Does that mean that whenever one initiates a put credit spread, one must set aside the full cash requirements of the short strike for the entire duration of the position? Is that what you have been doing Teddi? Do you keep enough cash to fully cover the exercise price of every single put credit spread that you initiate? If that is what one needs to do, and if one wants to earn 1% per month, then that 1% needs to be calculated on the total value of the short strike and not on the value of the spread. Option premiums rarely allow for those kinds of returns.

Teddi, your reply brought up two more questions:

1. You recommend that when one initiates a put credit spread, one must be willing to own the underlying shares at that strike. However, in your reply, you indicated that you did not accept exercise of the 45 short strike on WFC, choosing instead to close the short put for a loss and let the long put “ride”. If you were willing to accept assignment when you initiated the trade, why did you not then accept assignment of the short puts at 45?

2. You recommend closing a short put if the loss equals 50% of the profit made on that short puts. In other words, if the premium of the short put rises to equal 150% of the price received, you would buy back the short put. However, I believe that this situation happens on many trades, even if the short strike is not in danger of being violated. That would lead to closing most positions for a loss, even though they were not really in danger and would have been profitable. For example, I initiated a MSFT Apr 3 put credit spread (125/115) on Mar 27 when MSFT was trading at around $152. The short strike was sold for $0.43. Looking at the charts of the past week, MSFT never traded below $149 (very far from the 125 short strike) yet I see that the 125 put options premium was above $0.645 (50% loss) a few times (according to the chart on IB). That would have meant closing a position for a loss, even though it was nowhere close to being in danger. Can you please clarify this point for me?

Thank you for all your input.

[Investor237]

Thank you for all the feedback Teddi. It has helped lay the groundwork for me to understand some key concepts.

I will keep reading and learning.

[Investor237]

Thank you for the great feedback Teddi. I should inform you that although I have been using options for years, I am a new subscriber to your website, so I have not read all of your articles (if that is even possible given the large volume of articles).

If I understood your advice correctly, given my limited daily timeframe for trading, your opinion is that I should only trade in stocks or ETFs that I am willing to own. You also suggest that I spread the risk by allocating capital to a few different stocks, rather than allocating all my capital to one stock.

OK. I understand those suggestions and they make sense to me.

Given the limited amount of time I have to trade per day, I also feel that I should limit my trading to the put selling strategy, and not use the other strategies.

Let me ask you….

I am not a big fan of actually owning shares in any stock. No matter how “blue chip” it is, it can always drop significantly in price. Is there a way to trade the put selling strategies profitably, without ever accepting assignment? or am I obligated to accept assignment as part of the process to make the strategy profitable?

Also, you mention diversifying risk, by spreading capital amongst a few stocks. That would help mitigate individual stock risk, but would not help in an overall market downtrend as we are currently experiencing.

As mentioned, I am new to your website. There is a very large volume of articles. However, I don’t see any indication of the sequence in which articles should be read to learn a strategy. For example, there are a lot of posts on put selling, but no indication of the order in which they should be read to gradually build up my knowledge and understanding of the strategy.

You mention your BMO trade on March 12th. I could not find a post on it.

What made you pick BMO stock (as opposed to RY stock for example, which is also beaten dowm) to sell puts on?

What made you decide to sell on March 12 (as opposed to March 11th or Mar 16th…you had no way of predicting that March 12 would be the low for the stock…or did you?)?

Why did you pick the 105 strike price? I noticed that 105 seems to be a resistance level, but why would a resistance level be used as guide to selecting a put strike price?

Thank you again for all your kind advice.

[Investor237]

I know that you have not mentioned trades in RUT. I traded options in RUT because of its size. This allowed me to sell less contracts, which made for smaller commissions and less contracts to roll, if the need came up.

I did not trade put credit spreads for the same reason…more contracts to manage if I needed to roll them.

The following questions may sound aggressive, but that is not my intention. They are not meant to question your knowledge or advice, but are my way of clarifying things so that I can learn:

You say not to trade RUT, but that trading IWM is OK. 10 IWM contracts = 1 RUT contract. So if you are trading 10 IWM contract, you are basically trading 1 RUT contract. So why do you advise against one and not the other?

You say that I should have traded credit spreads instead of naked puts. That seems obvious in hindsight. A lot of the put options that you sell on stocks are cash-secured puts, and not credit spreads. So why are you recommending credit spreads on RUT? Yes, the long puts would have buffered the losses from the short puts, but that is known in hindsight. By selling credit spreads, I would need to sell many more spreads to collect the same premium as 1 naked put, which would leave me with the same theoretical risk, and many more contracts to roll.

In your reply, you suggested selling call credit spreads on up days, and then selling them on down days. When there is an up day and I sell call credit spreads, how do I know that the following day will not be another up day, thus adding to the losses? There is no guarantee that there will be a down day that would allow me to take profits from my call credit spreads (just like there have not been enough up days fro me to recover my losses from my short puts). As a perfect example, I closed a short put on RUT today around 3pm (my schedule only allows to me trade during the last hour of the day). The market was up for the day. Had I waited until 3:45pm, I could have closed that same position for $3000 less, but there was no way for me to predict exactly what the market would do during that 45 minutes. In hindsight I realize that I could have saved $3000, but I could just as easily have lost an extra $3000.

I guess that my last two paragraphs are asking the same question in different ways: the suggestions that you gave in your reply look great in hindsight, but how do you know that those suggestions would be trades that would maximize profits before the fact?

You give the example of BAC vs RUT. The only difference between the two is the price. A 4% drop in either one is a 4% drop. The option premiums of BAC and RUT will react similarly (in percentage terms) to a 4% drop…no?

You mention being assigned 300 shares of BAC for $9000. From your portfolio summaries (the last one being dated 2015) your total portfolio is over $1.2 million. A $9000 trade is less than 1% of your account. You would need to place 70 such trades if you wanted to use 70% of your account. If you want to generate significant profits from your total portfolio, you need to use it. 70 simultaneous trades are a lot to manage. Do you regularly place trades that account for just 1% of your portfolio? Don’t you scale the trades to match the size of your portfolio?

Again, I hope that I did not come across as aggressive. That was not my intent. I need to question your advice to better understand the reasoning behind it.

You ended your reply by asking what my current position is. That particular account had CDN $129,000 and US $14,000 in mid February (the CDN dollars were being used to cover the margin on the RUT contracts….the US dollars were generated by months of short RUT puts). After the margin calls, and closing all the RUT short puts, I am left with CDN $24,000. My account had literally been decimated by this market downturn. Any suggestions on a plan?

Thank you again for your time and your advice. Have a great weekend!

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