Selling puts on margin

[Sojourner]

I'm thinking of doing a bit more of this, to generate a trickle of income (probably no more than a few hundred bucks a month) and to pick up some shares of ETFs I'd like to own anyway, but at a discount.

The reason I'm considering using margin is that I want to be able to have 2-3 put options going at a time, and if I limit myself to cash-secured puts, I'll need to tie up more cash in very low-interest settlement/holding accounts than I'd want to. By using margin, I can keep most of my cash in higher yielding accounts and only transfer it over if my puts get exercised (which I've read happens only about 10% of the time).

I know the conventional wisdom is that using margin to sell puts is a high risk strategy, but in my case, with the fairly small amounts of trading I'd be doing, and the fact that I do (and will) have enough cash to cover any purchases "put" to me, I'm not sure I see it as very risky.

Also, any thoughts about using Vanguard to do this type of options trading? I get 25 free trades with them each year, which I figure I should use up before paying for trades somewhere else.

Welcome any and all advice or thoughts about this plan.

 

[FIRE'd@51]

If you sell naked puts, they will be marked-to-the market everyday and you may be subjected to a margin call if your account does not contain enough cash and/or marginable securities to meet the maintenance margin requirements. The puts needn't be assigned for this to occur.

 

[Sojourner]

Hmmm, perhaps I need to learn more about how margin maintenance requirements are calculated for naked puts. But it seems like if I were to, say, sell one put contract with a strike of $100, then the most I would ever need in my margin account to cover that would be $10,000 (of which some portion would be cash from me). Are you saying I might need more than $10,000 depending on how the price of the underlying security fluctuates?

 

[FIRE'd@51]

This will give you an idea:

Margin Calculator

IIRC Vanguard's requirements are higher, but you can check with them.

If you use securities, the amount available to meet the maintenance margin requirement will fluctuate with the securities' prices, so it is theoretically possible you could still face a margin call.

 

[Sunset]

The other surprise you may get is that all get called at once due to a big drop in the market, and you are left paying too much for these stocks.

 

[Hamlet]

The other surprise you may get is that all get called at once due to a big drop in the market, and you are left paying too much for these stocks.

Yeah, that is probably a pretty likely outcome of this strategy. You might go years with very few stocks put to you, and then get all of them put to you quickly in a market decline.



I don't think I would consider a strategy like that, especially at the currently fairly high market valuations.

 

[Quill1000]

Selling Puts on Margin

There is a way to pursue the strategy you are employing and largely mitigate the damage that would ensue should there be a severe and sudden market drop that could result in multiple securities being put to you.

If instead of selling your chosen puts naked, place a floor under your short put by buying a lower priced put at a strike price below that of your short put.

Base case
Example: sell a put on Microsoft (MSFT)
Today’s date: 6/8/2019
Stock price: $131 (roughly)
Sell 1 July 5, 2019 $125 put for a premium of $1.05
Required margin/cash = $13,100
Return on capital = $105/$13,100 or 0.8%
Days to expiration = 27 (27/360 = 0.075 of a year)
Annualized return on capital = 0.8%/0.075 or 10.6%
Excludes brokerage fees and any margin cost.

Alternatively, if we buy a put under our short put the transaction looks like this:
Sell 1 July 5, 2019 $125 put for a premium of $1.05
Buy 1 July 5, 2019 $115 put for a debit of $0.23
Our net credit on the transaction is $0.82 or $82 on 100 shares
Our margin requirement is reduced to $1000 ((125-115)*100)
Our return on capital/risk is now $82/$1000 or 8.2% and our
Annualized return on capital is 8.2%/0.075 or 109.3%
Now to make your actual take home dollars equal or better than the unhedged transaction, simply sell more contracts (in this form called credit spreads). If you did two of these credit spreads, your max loss is $2000, your max margin is (usually) $2000, your total credit is $164 vs $105 and your return on capital is 10x that of the naked put. This also frees up $11,100 in cash/margin for other transactions. As noted neither of these examples consider commissions of fees.

 

[NW-Bound]

Yeah, that is probably a pretty likely outcome of this strategy. You might go years with very few stocks put to you, and then get all of them put to you quickly in a market decline.

I don't think I would consider a strategy like that, especially at the currently fairly high market valuations.

One definitely does not want this strategy in a low market valuation. He wants to own stocks during a bull run.

If one is afraid of high market valuation, yet wants some return a bit higher than fixed income, this strategy may still be safe if one's stock AA is still reasonable, say 70% after all the options exercised. It means he currently holds much less than 70% stock AA. He would still be better than someone who holds 70% now, if the market tanks.

Of course, the market may just continue to climb and climb, and his performance will trail that someone with 70% stock AA currently, but that is the price of playing conservative.

People think of option trading as high risk, but it is not true. It all depends on how one uses it.

 

[gstillson]

Do what Quill suggested and do it in Robinhood so you have no fees.

Generate whatever monthly income you desire according to the risk you can stomach.

I don't really like spreads that much though. I have had some success with diagonals. More on the bull side of things (I know selling a put is a sort of bullish move...you don't think the market is going to crash but you don't think it is going to go sky high either).

I like buying a deep in the money call with a far away expiration date and then selling calls against it with nearer term out of the money calls, if the underlying stock allows for a good premium on the sales.

Maybe something like Amazon. Buy a June 2020 $1600 strike for $340 and then sell a August 2019 $1900 strike for $50. Keep rolling Sept, Oct., Nov, etc. Pretty soon you have made $300 profit on your $290 at risk investment.

 

[FIRE'd@51]

There is a way to pursue the strategy you are employing and largely mitigate the damage that would ensue should there be a severe and sudden market drop that could result in multiple securities being put to you.

If instead of selling your chosen puts naked, place a floor under your short put by buying a lower priced put at a strike price below that of your short put.

Base case
Example: sell a put on Microsoft (MSFT)
Today’s date: 6/8/2019
Stock price: $131 (roughly)
Sell 1 July 5, 2019 $125 put for a premium of $1.05
Required margin/cash = $13,100
Return on capital = $105/$13,100 or 0.8%
Days to expiration = 27 (27/360 = 0.075 of a year)
Annualized return on capital = 0.8%/0.075 or 10.6%
Excludes brokerage fees and any margin cost.

Alternatively, if we buy a put under our short put the transaction looks like this:
Sell 1 July 5, 2019 $125 put for a premium of $1.05
Buy 1 July 5, 2019 $115 put for a debit of $0.23
Our net credit on the transaction is $0.82 or $82 on 100 shares
Our margin requirement is reduced to $1000 ((125-115)*100)
Our return on capital/risk is now $82/$1000 or 8.2% and our
Annualized return on capital is 8.2%/0.075 or 109.3%
Now to make your actual take home dollars equal or better than the unhedged transaction, simply sell more contracts (in this form called credit spreads). If you did two of these credit spreads, your max loss is $2000, your max margin is (usually) $2000, your total credit is $164 vs $105 and your return on capital is 10x that of the naked put. This also frees up $11,100 in cash/margin for other transactions. As noted neither of these examples consider commissions of fees.

Actually, in your base case, the initial margin could be as low as $2020 (20% of the underlying stock price less the OTM amount): (0.2 x 131 - 6 ) x 100 = $2020 This is the CBOE minimum, although many brokers will require more, probably 25%-30% of the underlying.

Nevertheless, your suggestion to sell put spreads is an excellent one. Not only will it reduce your margin and raise your ROR, but it will eliminate the possibilty of a margin call if you post the $1000 in cash.

 

[Quill1000]

FIRED@51, you are absolutely correct on the margin. I do my put selling in IRAs and did not differentiate the ira account “margin” (which is more correctly a cash secured put). The one other thing I can say about credit spreads is don’t be greedy. If they go south, you will usually be looking at a loss that could be 3x or more the size of your initial credit. Keep your short strike as far from the money as you can and still get a reasonable return.

 

[copyright1997reloaded]

As a young pup in the late seventies/early eighties I used to go to the broker just about every day for lunch. I would research securities in the S&P guides and value line, page by page. Along the way I acquired invaluable knowledge:
1) Most/all of the brokers who were advising clients knew a lot less about security analysis as I did (as a 20 year old).
2) A gentleman was there, let's call him "Joe". "Joe" was a pretty smart guy, and would explain various option strategies to me. Calls, Puts, Collars, Butterflies, Spreads, and so on. He would go on and on about how they could be used to enhance profits.

Joe got wiped out.

Me? I stuck to the boring stuff, buying stock in companies with good prospects, clean balance sheets, and in industries I thought had good long term secular growth prospects w/decent barriers to entry.

Me? Retired at 51 with enough to not have to go back to work. (While I have gone back to work it has been by choice, not need.) I've made more in the markets and other investments than I made from working.

To each their own, but other than covered calls or in a few rare cases buying puts, I don't play in this game. Too complicated for me.

 

[haha]

There is a way to pursue the strategy you are employing and largely mitigate the damage that would ensue should there be a severe and sudden market drop that could result in multiple securities being put to you.

If instead of selling your chosen puts naked, place a floor under your short put by buying a lower priced put at a strike price below that of your short put.

This is the only way to do this kind of thing. Otherwise, you may get away with the exposure sometimes, but it can never be worth the risk you are accepting. To sell unhedged puts is not cool. Probably the most important investor mistake is to fail to visualize how volatile things can (not must, but can) become.

 

[gstillson]

I have a bunch of stories though about Bill, Jack, Darren, and Tim who all had call options (through company grants) and all became multi millionaires.

And yes while those are technically free, in reality sometimes a person takes a lower paying job along with the promise of these options, so another person could choose to buy long dated calls with some of the income from their higher paying job and luck out with a company like Amazon, Microsoft (recently), etc. just like Bill, Jack, Darren and Tim did.

 

[cyber888]

I sell Puts too and have make a good income out of it. You have to be careful with margins. Sometimes margins can adjust without warning and you get a margin call. So, you have to leave cash in case margins change, or be ready to close the Puts when the price goes down and you are heavy on margins.

I'm thinking of doing a bit more of this, to generate a trickle of income (probably no more than a few hundred bucks a month) and to pick up some shares of ETFs I'd like to own anyway, but at a discount.

The reason I'm considering using margin is that I want to be able to have 2-3 put options going at a time, and if I limit myself to cash-secured puts, I'll need to tie up more cash in very low-interest settlement/holding accounts than I'd want to. By using margin, I can keep most of my cash in higher yielding accounts and only transfer it over if my puts get exercised (which I've read happens only about 10% of the time).

I know the conventional wisdom is that using margin to sell puts is a high risk strategy, but in my case, with the fairly small amounts of trading I'd be doing, and the fact that I do (and will) have enough cash to cover any purchases "put" to me, I'm not sure I see it as very risky.

Also, any thoughts about using Vanguard to do this type of options trading? I get 25 free trades with them each year, which I figure I should use up before paying for trades somewhere else.

Welcome any and all advice or thoughts about this plan.