My 4 Basic Rules For Selling Puts (Naked
Or Cash Secured)
Rule #3
- Check The Moving Averages
I always check the 10 day simple
moving average (SMA) against the 20 and
30 day exponential moving average (EMA).
If the 10 day SMA has crossed and is moving
below the 20 and 30 day, I usually wait
for the 10 day to flatten out or turn
sideways or up to indicate to me that
the stock may have stopped falling
before selling puts. This
makes it more likely that I may not be
assigned on the puts I have sold. In
other instances, it provides an
opportunity for me to sell slightly in
the money puts for better premiums with
an opportunity that the stock may have
bottomed and will move back up, again
leaving my puts out of the money and not
assigned.
You can read this article on the
moving
averages trading strategy to understand more
about how the moving averages strategy works.
Here are some examples of applying Rule #3.
The first example is Exxon Mobil (XOM) from 2007. Using
the moving averages depends on the goal. If the goal
is to sell covered calls and earn a higher premium,
selling the call while the 10 day is moving up and
then turns, brings in very good premium. For selling
puts the opposite is considered. The 10 day SMA crosses
the 20 and 30 day EMA and moves lower. When the
stock has a good drop and the 10 day is flattening
or sideways or turning up, that's the moment when I like
to sell puts. If you look at the chart below I have
marked the indicators that I follow to sell puts.
For those interested in covered calls, I have marked
where I would sell covered calls.
This same strategy can be used by long term stock
holders who want to earn option premiums from
covered calls but hope not to be exercised out of
their stock. Below is a chart of Royal Bank Of Canada
stock (RY),
on the Toronto Stock Exchange (TSX) for March to
July 2011. If I was a long term holder of Royal Bank
Of Canada stock, I would like to augment the
dividend through selling covered calls. However
selling covered calls can often lead to the stock
being exercised by selling calls without actually
studying the charts. In the chart below I can see in
mid January 2011 that the 10 day SMA, crossed the 20
day and 30 day EMA. By waiting for the 10 day to
flatten out or turn sideways I can then sell
covered calls with less risk of assignment.
In the
instance below for example, I could sell the March
15 2011 Royal Bank April $60 strike for $1.00. Done
a couple of times a year, combined with the dividend
of $2.16, could earn $4.16 in income with not a lot
of work involved.
For those investors looking to get into the stock,
but not right away, the opposite is true. They can
follow the 10 day SMA as is falls, following the stock
lower. When the 10 day flattens out, turns sideways
or turns up, selling puts
makes a lot of sense. In the above example, on June
16 2011, an investor could have sold the July $54
put for $1.30, reducing their entry cost in the
stock to $52.70. With a dividend of $2.16, this
creates a 4% dividend return.
One last chart to look at. This chart is Google Stock (goog) for
July 2010 to July 2011. Many investors like to
purchase the stock and sell it following Rule #3. In
this example the investor spots the stock down
signal, waits for the 10 day to turn up and buys
stock. He then follows the 10 day up until it begins
to flatten out, turn sideways or turns down. Depending on the investor,
he may sell a deep in the money covered call if he
wants to generate some additional income just in
case the stock is not going to pull back but move
higher. Other investors simply sell the stock and
wait for another downturn, follow the 10 day SMA and get
ready to buy stock again to repeat the entire
process once the 10 day stops falling.
Summary Rule #3
By using Rule #3, I can better judge my moments
to sell puts. Other investors as you have seen, can
use Rule #3 to assist their investing philosophies.
One advantage to Rule #3 is the number of times it
has helped me not to sell puts as the stock is
falling only to discover the stock has further to
fall. Instead by following the rule and waiting for
the 10 day to flatten out or turn sideways or up, I
have a better chance to be selling puts with a
reduced chance of assignment.
