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Thursday, March 7, 2013

Covered Put -- New Strategy (for me)

Here we go again, UNLIMITED RISK!     The entire idea that any option strategy or stock strategy, for that matter, gives you unlimited risk, is simply NOT TRUE.

The brokerage (in my case, Think Or Swim) will 'freeze' a certain amount of your account when you short options.  Think of it as them holding some "collateral" on the trade-- it is roughly based on a formula of two standard deviations which gives the broker assurance that his risk is covered.  BROKERS DON'T ALLOW YOU TO TAKE UNLIMITED RISK!  So the whole "infinite" or "unlimited" risk warning is keeping traders from making the kind of trades that could earn them money.  The pros have this market cornered, whether you realize it or not.

If you doubt this, just try to make a trade that requires more margin than you have in your regular margin account.  The trade will be rejected!  Your REAL risk is the amount of margin that the broker holds when you place the trade.  So forget this unlimited risk business and learn how to short some options and stocks!!

Now when the market crashes a la 1929, don't tell me "See?"  We don't live our trading lives as if the sky is falling, Chicken Little.


Okay, I'm learning  another strategy for an underlying when YOU EXPECT THE STOCK TO STAY STAGNANT OR GO DOWN.   (Sosnoff at TastyTrade, a confirmed Contrarian, used YHOO as his example in teaching his daughter, Case Sosnoff, how this works.)

Sell Stock and Sell an ATM put against it.  That's it in a nutshell.

For instance:

Suppose ABC stock is trading at $45 in June. An options trader sells a JUL 45 put for $200 while shorting 100 shares of ABC stock. The net credit taken to enter the put position is $200, which is also his maximum possible profit.
On expiration in July, ABC stock is still trading at $45. The JUL 45 put expires worthless while the trader covers his short position with no loss. In the end, he gets to keep the entire credit taken as profit.
If instead ABC stock drops to $40 on expiration, the short put will expire in the money and is worth $500 but this loss is offset by the $500 gain in the short stock position. Thus, the profit is still the initial credit of $200 taken on entering the trade.
However, should the stock rally to $55 on expiration, a significant loss results. At this price, the short stock position taken when ABC stock was trading at $45 suffers a $1000 loss. ($55 X 100) $5500 - $4500 SHORT = $1000 LOSS.
Subtracting the initial credit of $200 taken, the resulting loss is $800.

Think of this strategy as a mirror image of the Covered Call, BUT much lesser known and lesser used than the covered call.

A covered call profits from a stagnant or bullish move.

A covered put profits from a stagnant or bearish move.

Two chances to win out of three are pretty good odds, especially if your expectations are fairly lucky!

Happy Trading!

  • lly, you should buy to close the short put options.

    1. Oh! My God!!!!. What a coincidence! I can’t believe that there are many friends out there like me travelling in the same boat on rough journey to a common destination. Common qualities like spending thousands of dollars on stocks/options education, Optionetics, Option Animal, Kirkland advisory(and of-course bad experience with them), trekking the web, fond of check lists, excited about every seminar and course and thinking that “THAT’S IT’ and coming back to square one..etc I think we are almost there by landing at Tasty Trade and Think Or Swim. I’m also exploring Futures on Options (finished Jamse Cordier book).

      Bev, I really consider myself fortunate finding your blog. Sharing your trade ideas and your valuable education is greatly appreciated. I know the value of those, price less. I’m sure one day you’ll become another super trader like Karen.

      Please continue to share your valuable insights and looking forward more great articles from you. I’ll also share my valuable trading strategies which I’ve learned by spending huge amount of money.

      Did you make any progress on futures on options.

      Keep sharing.



    2. Shine~! (I love your name). Thanks So much for writing. I'm thrilled to find fellow traders in this lonely ol' business of options. Please do share with me all good things you learn. I'm forever learning (and I think we will be forever, as these options never stop. Now the mini options~~!!) That's my purpose with this blog, to try to pass on what I learn, pathetic as it might be.

      Listen I started to trade futures (the futures themselves, not options on them) and it screwed up my fund. You need to keep a minimum because of day trading rules or some such, and they split the futures trades into a DIFFERENT account, moving my monies from my option fund to a futures fund~! Really irritated me because I was then prevented from doing day trades of any kind for 90 days or until I brought my account balance up. So I closed all the future trades, and haven't ventured into them again. I'm pouting, as I don't think two separate funds should be required. I do occasionally trade options on futures, but that's just like trading any other stock...you don't get that fabulous margin relief that futures give you. So I'm now trying to earn enough to have TWO funds that stay in the limits of the Stupid Rules.

      Visit me again, great to hear from you, and thanks for writing~

    3. Hi Bev

      I'm also very interested in options, thanks for your great blog. I noticed you used to use tos which I've tried in the past and liked a lot - but it's not available in the UK now and as your blog is co.uk I was wondering it they booted your account or is tos still available in UK?

    4. My blog is NOT co.uk ????? How odd. It's bevjackson.blogspot.com. I am still on Think or Swim and wouldn't go elsewhere. The best platform I've ever had, even though there is a learning curve, it's well worth it. I don't understand why you're not able to get it? I'm sure others do? I'm pretty sure it's international (though I don't really know that for fact.)