PUT SELLING is not always a winning strategy. The belief among investors is that more options expire worthless than are assigned. While statistically this is of course true, the real statistic should be how many at the money options expire worthless. That would be a much more interesting put selling statistic and might surprise a lot of investors who engage in put selling as their principal method of earning profit and income. I wouldn’t mind even a statistic on how many slightly out of the money puts expire worthless. That type of statistic would help enormously in making a put selling decision.
However at the same time I would still be determined to keep my trade journal up and stick with put selling against stocks that I would own if I have to. For example, a reader has written me regarding a terrible loss on put selling PBR Stock. PBR Stock is Petrleo Brasileiro SA Petrobras which trades on New York. Presently trading at $23.90 it has a valuation of 7.9 times price to earnings. It is trading below book value which is pegged at $26.96. Profit margin is 13.70% and has a fluctuating dividend payout which right now is $1.25 which works out to 5.11% annual. Payout ratio is in line with most oil companies at 34.3 times.
Put Selling Gone Bad
The reader who wrote me indicated he is holding 5 April $35 puts which he has already taken a loss of $1511.70 to roll down to. I do not know what the original put selling strike was or how much was made or anything prior such as when did this happen. So I am starting from scratch on this one, but my answer would be the same even if I knew.
Here is part of the reader’s email on this put selling disaster:
PUT SELLING QUESTION FROM READER ON PBR STOCK
I’ve got a problem stock, PBR Petro Brasilio, current price $24.90, I’m ROLLED INTO APR 35 PUTS. When I started selling NP’s on the stock, I did want to own it. Now it’s a different story. I no longer wish to.
So here’s my dilemma. I’m in a losing position on a stock I don’t wish to own and have considered the three scenarios listed below; CLOSE POSITION, ROLL POSITION OR TAKE ASSIGNMENT.
I have the capital to take the stock and hold until it rebounds meanwhile selling covered calls. I will then have to deal with a problem child for a long time. So do I cut to the chase and:
CLOSE options taking the loss or
BTC 5 APR 35P / 1095 -$5475.00
previous roll loss -$1511.70
total LOSS -$6986.00
OR
ROLL 5 apr to 5 MAY 35P net positive, but kicking the can down the road.
$85.00
OR
Take ASSIGNMENT & sell Covered Calls to recoup (realizing it’s possible for stock to fall more)
Assign: 500 @ 35.00 strike -$17500
previous option loss – 1511
Stock Current VALUE: 500/24.90 11950
own stock w loss basis of -$7061.00
I’d appreciate your thoughts. I’m willing to work this through and chalk it up to another lesson.
Put Selling My Way
There are two things that really come to mind right away:
The First is that these types of lessons are expensive and can damage a portfolio. Remember that put selling is a strategy of small gains. When you sell a put option for.50 cents you have immediately received your profit from that trade. That’s your profit, period. You have earned .50 cents. If you have too many trades where you end up buying the puts back for $1.00 or $2.00 or more, this is an incredible loss and wipes out earnings from other trades. Think about how many put selling trades you must do to earn that big loss back.
When you engage in selling puts as an investment strategy there are 5 primary reasons:
- Selling Puts For Income
- Selling Puts For Profit To Compound Your Capital
- Selling Puts For Buying Stock At A Discount To Its Present Value
- Selling Puts To Buy Stock At A Variety Of Strikes – Basically Laddering Into A Position
- Selling Puts To Buy Stock For Covered Call Writing
These are the primary reasons for selling puts. Every investor needs to ask themselves which of the above 5 is why they sold puts. If selling for income or profit then naturally you would set a stop-loss immediately after the put is sold. Perhaps 50% loss. So if you sold a put option for .50 cents and it rose to .75 cents you would buy to close and take the loss of .25 cents. After all the put selling strategy was to earn income or profit NOT LOSE IT.
For the remaining 3 put selling reasons, the answer there is obvious. It doesn’t matter what happens after you have sold your put options. The stock can fall, or rise, whatever because you want the stock.
The Second thing that immediately comes to my mind is how much I hate companies that I do not know and are not American or Canadian based. I love a company like Coca Cola for example (Stock symbol KO). I was in this company when it collapsed in value NUMEROUS TIMES. You can read about all the KO Stock problems in this article on put selling over-valued stock. During those numerous time it never bothered me to get stuck holding the stock. Often I ended up selling puts even lower to average my cost down. I remember over a period of 3 years I was assigned several times through selling puts and finally ended up with 4000 shares of Coca Cola Stock with an average price of only $44. Then Coca Cola Stock Sold Off to $38.50!
But I never worried because I knew Coca Cola Stock even if it fell to $20.00 would be a good buy. I set aside a specific amount of capital for my Coca Cola Stock trade and kept working that stock until it recovered. In the end I made a lot of profit on my positions. The difference here is that Coca Cola Stock I KNOW is going to be around and will continue to increase its dividend and eventually will reflect its true value.
Can the same be said of PBR Stock?
PBR has a market cap of $157.9 Billion and revenue of $145.9 Billion. This is a huge company. Chevron for example has a market cap of $198.9 Billion and revenue of $253.7 Billion. The annual dividend is $3.24 for a yield of 3.13% and the profit margin is 10.65%. It is trading at 7.5 times price to earnings and has a book value of $61.27. It is trading for $103.45 today.
The question this reader must ask is what has changed in her outlook for PBR Stock? I know nothing about PBR Stock. It has done a 2 for 1 split which you can see on the PBR Stock chart below. The stock is definitely in a waterfall sliding constantly lower.
PBR Stock 5 Year Chart
Ask Yourself This:
If Chevron stock today fell to $65.00 as it did in the 2008 to 2009 market panic, and you had sold the $100 put what would you do? Would you bail or would you look at the fundamentals of the company. Would you jump in and buy a bit of stock and begin to build a solid investment in Chevron stock realizing that you have some shares at $100.00 and because of a panic you now have some shares at $65.00 and if it fell lower you would buy some more shares. Investing for many people is about long-term gains. It is about building a position in a stock you know and follow. It is about cherry picking the great companies that will survive everything from recession to wars, currency fluctuations and more and they MUST PAY A DIVIDEND.
Is PBR This Kind Of Stock?
So is PBR Stock the right pick to build a position in? If it once was, why not now when it is on sale? What has changed? Is it just because it is now lower which if you like PBR Stock is exactly what you want.
Put Selling Is More Than Just Tiny Profits
Every investor has their own way of looking at investing through options. Put selling in my strategy is more than just small profits each month. It is a strategy built on trading against enormous companies that have long-term potential for growth, dividend increases and profit expansion. Every single company on my website has potential. Every company I am selling put options against has that potential. WHEN THEY DO NOT HAVE THE POTENTIAL I STOP PUT SELLING.
So The Answer Is Obvious On PBR Stock
The answer for this reader is obvious. If the reader had not sold puts at $35.00 would he be selling puts today at $22 or lower? Would he be thinking that with PBR Stock this low, it is a huge opportunity and be jumping in to sell puts even lower hoping to get stuck holding stock at or even below $20.00?
Or does the reader believe this company has no potential and is going to end up back below $15.00 which is where it was more than 5 years ago and never recover. If he believes there is no potential then naturally the choice is take the loss and get out. There is no point in put selling against a stock that he believes is just going to collapse further. There is no point is owning shares and selling covered calls against a stock that he believes has no future.
On the other hand if he believes this company is ON SALE right now then he would begin to build a sound strategy and work this trade into a terrific profit.
With the options expiring tomorrow I cannot tell this reader what to do, but I don’t think it is really necessary. I believe the reader probably knows what to do.
When the reader who sold puts did the original put selling what did they know about this company. Why is there now doubt about this position. Did the reader believe as long as the stock moved higher he wanted this stock? Is that what the reader believed because after all this is what almost all investors believe. Investors always believe stocks are going to just keep on rising.
BABY IN A CANDY STORE
Investors also love the IDEA of a crash in value and picking up shares on the cheap, but when it happens they never actually do. Instead as the stock falls deeper and lower than they thought possible, they fret and worry even more when instead they should be excited as a baby in a candy store and slowly start to build that position.
In the bear market of 2008 – 2009 I was buying shares like mad. I bought 1000 shares of Citigroup for .99 cents. Honestly, .99 cents?? I bought 1000 shares of Ford Stock for $1.85. Why was everyone dumping Ford Stock when not only did they NOT seek government hand-outs but told everyone they could survive without the government, thank you very much. What did this cost me? $990.00 and $1850.00. Not much to risk.
Investors will claim they didn’t act because it seemed like the end of the world was at hand. That all auto manufacturers were going to be wiped out, all banks, all stocks in general.
But guess what, in March 2003 I bought Ford Stock for $6.80 and EVERYONE was talking about the end of the automobile industry in America back then too. The year earlier PepsiCo Stock in September 2002 collapsed in the bear market and I jumped in and sold puts at $38, $36, $34, $30 and $28. I ended up picking up 4000 shares in total with an average cost of $35.00. My final covered call on all 4000 shares was in July 2007 at $62.50. Then much to my surprise PEP Stock went on sale AGAIN in 2008 to 2009! Here are some of my trades from 2009.
If You Want To Stay In PBR Stock Long Term
I think I have more than made my point. If the reader wants to stay in this stock long-term and thinks there is potential from here, then it is time to start building a position and use the Ultimate Oscillator and Fast Stochastic to help time entry and exit points.
IF THIS WAS MY POSITION AND I LOVED PBR STOCK BEING ON SALE THIS IS WHAT I WOULD DO. I have capitalized this sentence because this is in no way a recommendation to this reader OR ANYONE ELSE. TRADE AT YOUR OWN RISK. If ann investor cannot make a decision then they should not be investing.
There are dozens of strategies which could be used.
Recently I wrote an article covering AGQ ProShares and discussing 4 different strategies. All of these strategies could be applied to this rescue effort. Those strategies were The Gambler Covered Call Strategy, The Cry Baby Strategy, The Twin Sister and The Shark. (shameless plug for my PDF article) Joking aside, all 4 of those strategies could easily be applied to this trade while waiting for the stock to recover. The worst thing any investor should do is simply hold and wait, when that same investor could continue to earn income and reduce his overall cost within his position.
Below are TWO very simple strategies that could be applied without much work to this position in PBR Stock. I will approach this as if it was my PBR Put positions.
PUT SELLING MY WAY TO A RECOVERY
STEP 1: Decide How Much Capital To Commit and How Much Margin I Am Willing To Risk
STEP 2: Roll my puts from April to October and reduce the number of put contracts by 1 contract and roll down 1 strike. So today I buy back the April $35 for $11.15 total cost = $5575.00. I then sell the Jan $34 for $10.30 = $4120.00 – Loss is $1455.00 plus previous loss of $1511.70 for a total loss of $$2966.70.
STEP 3: Sell 1 January $30 put for $7.50 = $750.00 income. Total Loss is Now $2216.70 and I am holding 4 puts at Oct $34 and 1 Put at Jan $30
STEP 4: Get the stock chart up and use my Margin to sell FAR OUT OF THE MONEY PUTS to bring in small profits each month and close those options early. Wait for the Ultimate Oscillator and in particular the Fast Stochastic to turn up and then sell the May $21 strike with margin. 5 put contracts for .15 cents. = $75.00. Do this every month based on the Ultimate Oscillator and Fast Stochastic readings. Once that option is trading for .05 cents, BUY IT BACK.
Total return = $50.00 X 12 months = 600.00 . = Total loss then would be $1616.70. Once I have sold the put option I immediately enter an order to buy to close for .05 cents. That forces me to take a profit in the event the stock climbs.
STEP 5: ALTERNATE: – I could instead consider selling puts at the May $20 strike for .09 cents. Sell 10 which if assigned shares at $20 would mean:
1000 shares at $20.00 = $20,000
400 shares at $35.00 = $14000
100 shares at $30.00 = $3000.00
Total invested = $37,000.00 / 1500 shares = $24.66 per plus my loss to that point.
————–
Covered Calls To Recovery
I could accept the shares at $35.00. This entitles me to the dividends. Now I can sell covered calls each time the Ultimate Oscillator and Fast Stochastic has hit overbought and the stock pulls back. THAT IS THE PRIME POINT to sell covered calls. Again this is seen in The Gambler Strategy. I can take the capital earned from using the Gambler strategy and use it to trade further in PBR Stock including buying some shares and selling more covered calls.
Look at the example below. The first indicator in the chart below is the Fast Stochastic. The second indicator is the Ultimate Oscillator.
Using The Fast Stochastic and Ultimate Oscillator To Time Selling Covered Calls
On March 2 the Fast Stochastic was at 94.58 which is over bought BUT IT WAS STALLED. You can see that it turned flat.
The Ultimate Oscillator was FLAT at $51.67. It never even registered the rise in the stock. This is almost always a sign of the stock rally topping out. This means there is no buying conviction. If there was buying the Ultimate Oscillator should be higher. At that point even if the stock moved up, the chance of the stock staying up is low based on no buying. I would have sold the April $30 call which should have traded for around $1.40 cents. Total income = $700.00
If I wanted to use margin on my covered calls I would have also sold 5 April $32 covered calls which should have traded for around $.85 cents for $425.00
IF THE STOCK ROSE AND YOU LOST YOUR SHARES it would not matter. You are already holding a losing position. This has just made the loss that much smaller. You can also go back and buy the stock and sell covered calls again if you wanted. Therefore selling on a rise which is pinpointed by the fast stochastic makes a lot of sense. It is almost a win win situation.
COVERED CALL CHART 2
Time To Buy To Close Covered Calls and Sell More thanks to the Fast Stochastic and Ultimate Oscillator.
On March 28 you can see in the chart above that the stock pulled back after trying another mini rally. The fast stochastic fell back and crossed lower which normally marks another downturn for the stock. The Ultimate Oscillator is flat. Still no buying conviction. I would have bought back the 5 April $32 covered calls sold on margin and sold the May $30 for .40 cents for another $200.00.
Now the April $30.00 are the MARGIN naked covered calls and the MAY $30.00 are the stock covered calls.
Every time these calls fall to .05 cents I would be closing them and waiting for the next signal from the fast stochastic. I WOULD NEVER SELL COVERED CALLS WITH THE FAST STOCHASTIC OR ULTIMATE OSCILLATOR HITTING OVERSOLD.
Total income earned in 3 months of trading = Approx = $1325.00 less buy back 5 X .05 = $25. March dividend earned .136 X 500 shares = $68.00. Loss on position has been reduced from $7061 to $5693 or 19% reduction. Based on this strategy it would take 4 more quarters to reduce the loss to 0.00. At that point my $35.00 shares in PBR Stock would be worth $20.87 a share and I can continue selling covered calls further out of the money while I wait for the stock to recover and generate a very nice profit for my effort.
Put Selling Disaster in PBR Stock Summary
I think enough has been said on this stock to indicate how I feel about investing in general and put selling specifically. There are dozens of strategies that could be used to rescue this trade. The above two are very simple strategies that rely on the market timing technical tools, Ultimate Oscillator and Fast Stochastic to time moments to sell puts and when to sell covered calls. An investor could even use both put selling and covered calls together in the above rescue effort.
But without conviction that the stock is going to recover, that this is truly a great company that is on sale, then I think the answer about what should be done is obvious.