Could have been assigned, but took in a bit more premium ...

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Let me start with closing the "story" on last week's thought process to being assigned.  In last weekend's blog entry here I gave excruciating details on three stocks/option plays where the underlying had been put to me.  The three symbols were AMAT, MU, and SQ.

The gist of the story was that I had maximum profit potential at the following levels in these three stocks, which were all part of individual covered-calls:

• AMAT:  $300 maximum profit (put to me at $50 and potentially called away at $53)
• MU:   $300 maximum profit (put to me at $41 and potentially called away at $44)
• SQ:   $150 maximum profit (put to me at $41.50 and potentially called away at $43)

These underlyings were all in the money (ITM), so would have been called away with options expiration.  The closing values for each were:

• AMAT:  $54.90, ITM $1.90
• MU:  $44.21, ITM $0.21
• SQ:  $44.11, ITM $0.11

I noticed that as we were coming up into 3:59 pm ET, I had an opportunity to close the option leg and then close the stock, as the combined proceeds of closing the leg and selling the stock would have been greater than simply having the underlying's called away.  So I (rapidly) closed the following trades (ignore AVAV -- not part of this story) to capture the excess premium:

Here is how that story turned out:

So, for SQ, I was anticipating a $150 maximum profit but was able to capture $260-$71 = $189.  For both MU and AMAT I was expecting $300 maximum profit but was able to capture $321.25 + $4.00 = $325.25 for MU and $504.25 - $178 = $326.25 respectively.

I readily acknowledge that this is not the norm but I was able to do this, resulting in $90.50 increased value capture ($840.50 versus an anticipated $750).  The final numbers for each of these trades is as follows:

AMAT

• Premium from CSP (incl commission): $40
• Premium from CC:  (incl commission): $29
• Days from selling CSP to CC expiration:  12
• Original CSP amount:  $5000
• CC-CSP Value:  $300 (if ITM)
• Additional net premium/value received from sale:  $24.25 =  ($504.25 - $300 - $178 - $2)
• Total profit:  $393.25 = $40 + $29 + $300 + $24.25
• Return on AMAT transaction chain:  $393.25 / $5000 = 7.865%
• Annualized return on AMAT transaction chain:  7.865% * 365 / 12 = 239%

MU

• Premium from CSP (incl commission): $44
• Premium from CC:  (incl commission): $24
• Days from selling CSP to CC expiration:  19
• Original CSP amount:  $4100
• CC-CSP Value:  $300 (if ITM)
• Additional net premium/value received from sale:  $23.25 =  ($321.25 - $300 + $4 - $2)
• Total profit:  $391.25 = $44 + $24 + $300 + $23.25
• Return on MU transaction chain:  $391.25 / $4100 = 9.542%
• Annualized return on MU transaction chain:  9.542% * 365 / 19 = 183%

SQ

• Premium from CSP (incl commission): $29
• Premium from CC:  (incl commission): $39
• Days from selling CSP to CC expiration:  19
• Original CSP amount:  $4150
• CC-CSP Value:  $150 (if ITM)
• Additional net premium/value received from sale:  $37 =  ($260 - $150 - $71 - $2)
• Total profit:  $255 = $29 + $39 + $150 + $37
• Return on SQ transaction chain:  $255 / $4150 = 6.144%
• Annualized return on SQ transaction chain:  6.144% * 365 / 19 = 118%

So, the plan worked out in my favor. It doesn't always go this way, but I wanted to close the loop so that you can see how to do a cradle-to-grave analysis on the trades.

~~~~~~~~~

I closed a couple of other trades this week; here is the accounting:

1. AVAV 180216P50 was sold on 1/16 and I collected $0.90 at $1 commission.  I bought the position back on 2/16 for $0.05, netting $90 - $5 - $2 (commissions) = $83.  The duration was 32 days, inclusive of start/ending dates.  ROO was $83 / $5000 = 1.66% and AROO was 1.66% * 365 / 32 = 18.9%, including all commissions.
2. EXEL 180216P28 was sold on 2/5 and I collected $0.50 at $1 commission.  I bought the position back on 2/15 for $0.05, netting $50 - $5 - $2 (commissions) = $43.  The duration was 12 days, inclusive of start/ending dates.  ROO was $43 / $2800 = 1.54% and AROO was 1.54% * 365 / 12 = 46.7%, including all commissions.
3. TSN 180223P70 was sold on 2/12 and I collected $0.30 at $1 commission.  I bought the position back on 2/15 for $0.05, netting $30 - $5 - $2 (commissions) = $23.  The duration was 4 days, inclusive of start/ending dates.  ROO was $23 / $7000 = 0.329% and AROO was 0.329% * 365 / 4 = 30.0%, including all commissions.
4. XEL 180216P27 was sold on 2/8 and I collected $0.30 at $1 commission.  I bought the position back on 2/15 for $0.05, netting $30 - $5 - $2 (commissions) = $23.  The duration was 8 days, inclusive of start/ending dates.  ROO was $23 / $2700 = 0.85% and AROO was 0.85% * 365 / 8 = 38.9%, including all commissions.
5. NVCR 180216P20 was sold on 2/12 and I collected $0.35 at $1 commission.  I bought the position back on 2/15 for $0.05, netting $35 - $5 - $2 (commissions) = $28.  The duration was 4 days, inclusive of start/ending dates.  ROO was $28 / $2000 = 1.4% and AROO was 1.4% * 365 / 4 = 128%, including all commissions.

I did not have one losing trade all week.

~~~~~~~~~

Here's how I am positioned going into the President's Day shortened week:

COP 180223P55 is ITM right now, with the underlying sitting at $54.77.  If nothing changes this will be put to me at the end of the week.   I bought this on 2/5 and received a premium of $0.50.  Maximum option pain indicates a bit higher movement is possible this week, but of course, this is pure speculation (option pain does not always reflect reality):

PYPL 180223P75 is OTM right now, with the underlying sitting at $78.16.  I collected $1.00 in premium on 2/5.  Option pain suggests that this could come down towards my strike by the end of the week:

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SQM was Put to Me

I sold SQM 180216P55 on 1/18 for $0.95.  Friday's SQM close was $54.56, so I was put the stock at $55.00

From a Greenfield perspective, SQM meets all of my criteria.  I do not mind holding this stock at all, except that a month is a long time to wait for the next OE :)

SQM reports earnings on 2/28, after the close.  I am expecting that EPS will be higher but revenues will be lower, and given where we are in the ER cycle as a whole, I think they will get punished.  

An ATM credit straddle is showing about $3.20 expected movement from Friday's close, using the March expiration.  Of course, this needs to be re-evaluated the day prior to ER, but this suggests that I should be looking to sell a call at least above $54.56 + 3.20 > $57.76, or at a strike greater than $58.  The nearest strike is $60, so at a bid premium of $0.80, let's see if it meets the 20% requirement.  With 25 days left to March expiration, we have:

$80 / $5500 * 365 / 25 = 21.2%

Barely.  The delta at the 60 strike is 0.26, which (loosely) infers that there is a 74% chance of being OTM and holding the position at OE.  I like deltas 0.20 or lower.  

The order for Tuesday (Monday is a holiday) is STO 180316C60 limit $0.85.

SQM Trade Analysis

If the price of SQM rises above $60, I'll make $500 from the stock appreciation (put to me at $55 and called away at $60), plus the premium from the CSP of + $94 (incl comm), plus this CC premium of $79 (premium of $80 less $1 comm), so $173 in total premiums, for a total of $673.  The original amount invested was $5500 on 1/18 (cash secured put), so for 33 + 25 = 58 total days the annualized return is (673/5500) * 365/58 = 77%.

If the price of SQM is above $55 but below $60 then I'll still have the amount above $55 as paper profit plus the banked premium of the CSP ($94 incl comm), plus the banked CC premium of $79 (incl comm).  The call will expire worthless and I keep the premium.  The AROO for all premium received ($173 incl comm) and amount tied up ($5,500) is 19.8% (= $173 / $5500 * 365 / 58).  I could sell the shares on the market to collect the paper profit or I could sell another call against the underlying.

If the price of SQM is below my new break even of $55.00 - $0.94 (CSP) - $0.79 (CC) = $53.27 (3.14% reduction off of retail) or lower I'll still be underwater (but owning a quality stock).  I keep all the premiums and will sell another call to further lower my basis.

~~~~~~~~

I have the following CSPs in play right now:

EXEL 180316P25
SRNE 180316P5
ECHO 180316P25
SQM 180316P50
SAIA 180316P70
NAV 180309P35
PYPL 180223P75
COP 180223P55

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If you see anything wrong in my calculations, please let me know.  I think I have all of the bugs out of the spreadsheet that I used, but ya never know until others look at it.

As with all my ramblings, you are responsible for your own investment decisions and I am not.  Please do your own diligence, and please take ownership for your actions.

Regards,

pgd

Being Assigned is Not Necessarily Bad

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Investing in cash-secured puts (CSPs) and covered-calls is a cyclic process.  Here's a flow-chart that captures the essence:

I was assigned a few positions this weekend after a few of my CSPs were in the money (ITM) as of yesterday's (2/5) close.  What follows is an accounting of the math I'm using to show the CSP side of the equation, snapshot the picture facing me immediately after assignment, and see how to turn these into winning trades.

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Three stocks were assigned this past weekend:  AMAT, MU, and SQ.  I go into some detail on AMAT and the calculations, but condense this analysis for MU and SQ.

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First Assignment:  AMAT

Rule 1 of CSPs:  only sell puts on stocks that you would have no issues owning.  AMAT is a quality stock in terms of EPS and revenue growth. 

I sold the weekly AMAT 180209P50 on 2/5 for a credit of $41.00 ($0.41 * 100).  At the time the price was $51.35, and the historical volatility was 43%.

If the price closed above $50 the unexercised return on the option (UROO) would have been 0.81% including commissions; I typically try to buy these back at $0.05 or $0.10.  Using the $0.05 value my actual closed return on the option (CROO) would have been 0.69%.  The annualized return on the option (AROO) using the forced closed numbers, and knowing there are only 4 days that the order is alive, results in a AROO calculation of 62.54% (  = CROO * 365 / # days to exp ), including round-trip commissions ($2 total).

If assigned, breakeven for the stock is the strike price minus premium + commission, or $50 - $0.41 + 0.01 = $49.60.

The underlying closed ITM at $48.35, so the stock was assigned to me overnight.  The average price from my broker is the strike price of the put, in this case, $50.00/share.  

Any rise in the price above $49.60 is profit.  If I sell a call against it, as long as the call is above $49.60 (less the premium received), I'll make money.

So, what to do next?

AMAT is coming up on an earnings release next week, Wednesday, Feb 14, after the close (ATC).

I'm slightly bullish on AMAT in terms of REV and EPS, so I think it will bump to the upside.  

There are a couple of ways to calculate an expected move:

(1)  The first way to calculate the range is to see what the market thinks the current range could be.  Of course, this needs to be recalculated just before earnings release, and that's not always feasible (it certainly is not for me). In general, the expected trade range can be calculated using a short at-the-money (ATM) credit straddle, multiplying this by 0.85 (see this link), and then adding/subtracting it to the current price.  The $48.50 strike has a call bid of $1.63 and the put bid is at $2.13.  Doing the math shows that we could see a move of +/- $3.20 or so if the earnings report was tomorrow.  This gives us a rough expected range of $45.15 to $51.55.  Using this method, as long as my call is above $51.55, there would only be a 32% chance of having the position called away (e.g. a 68% chance exists that the price would be below the strike if it were perfectly at $51.55).

(2) Method 2 is the same as method (1) above but does not multiply by the 0.85.  Link here.  This suggests that we have the credits for the ITM short call and put totalling $3.76 and with the last close of $48.35, the implied volatility is 7.78% with 7 days to go (3.76/48.35).   Multiplying the last close by 1.0778 = $52.11.

Method 2 is more conservative so I'm going to use that for now.

So, it appears as long as I have a strike above $52.11 there will be a better than 68% chance that I will be out of the money (OTM) on expirations day.

The delta of a specific option can be taken as the percent likelihood that the position will finish ITM.  This is not an exact 1:1 relationship, but it's close enough, certainly to the nearest 10% or so.

I like any delta less than +0.3 for selling calls and less than -0.3 for selling puts.  I also require that any call or put I purchase have an AROO in excess of 20% (annualized).

5 trading days exist between me and expirations. If I require an annualized return of at least 20% and I have only 5 days left, the equation is:

20% * 5 / 365 = CROO (Closed Return on Option) = 0.27%

So, any premium that results in me getting at least 0.27% in 5 days is worthy of my efforts.

My cost basis on the stocks is my break-even * 100 shares, or $4,960.

0.27% of my cost basis is $13.59, or $0.14.  Because there is a $1 commission in here I'll add another $0.01 to show I need at least an option premium of $0.15 to make this 20% minimum.

So, here's the criteria for selling the call:

1) It has to be of a strike higher than $52.11.  This implies at least $52.50 or $53.
2) Whatever the strike, I have to collect at least $15, and prefer to do it with a delta under 0.3.

One (laborious) way I do this is plot the bid/ask midpoints/delta for each of the call strikes, and look for discontinuities in the curve.  Here's an example for AMAT and call options that expire on 2/16 (this week):

This plot shows the change in premium received / change in delta for each strike, as well as the raw premium received / delta.  As you would expect, as the strike moves further away from today's price  the delta drops, and we also see that the premium received also drops.  The ratio is not constant though, and as we get further OTM premium drops faster than delta. This can be interpreted "less chance of a strike being ITM, the lower the premium received".  The red dots are almost in a straight line, but the blue dots are not.

It doesn't always look like this, but the discontinuity for selling an AMAT call at strike = $53 (at a delta of 0.1648, not shown), is kind of a beacon to me to sell this strike.  It basically says "there is an 84% chance that anything you collect here will be pocketed, and although you may collect more at the $52.50 strike, the risk is disproportionate."

Think about it.  The blue dot is change in premium received from the next lower strike / change in delta.  So, when moving from the 52.50 strike to the 53 strike, EITHER the premium did not drop as much or the risk (delta) went down far more than expected.  Discontinuities do not last long in the market so the midpoint price (bid = $0.42 and ask = $0.31) of $0.36 could be a limit sell of $0.30 and still I would make all my targets.

Whatever the cause, the $53 strike calls for me.

A final check is to ensure that there is open interest (OI) at the strike.  The $53 call in AMAT has 717 contracts as I write this.

The order will be STO 1 AMAT 180216C53 Limit $0.30 DAY.

AMAT Trade Analysis

If the price of AMAT rises above $53, I'll make $300 from the stock appreciation (put to me at $50 and called away at $53), plus the premium from the CSP of + $40 (incl comm), plus this CC premium of $29 (premium of $30 less $1 comm), so $69 in total premiums, for a total of $369.  The original amount invested was $5000 on 2/5 (cash secured put), so for 12 total days the annualized return is (369/5000) * 365/12 = 224%.

If the price of AMAT is above $50 but below $53 then I'll still have the amount above $50 as paper profit plus the banked premium of the CSP ($40 incl comm), plus the banked CC premium of $29 (incl comm).  The call will expire worthless and I keep the premium.  The AROO for this premium ($29 incl comm) and amount tied up ($5,000) is 42.34% (29/5000*365/5).  I could sell the shares on the market to collect the paper profit or I could sell another call against the underlying.

If the price of AMAT is below my new break even of $49.60 - 0.29 = $49.31 or lower I'll still be underwater (but owning a quality stock).  I keep all the premiums and will sell another call to further lower my basis.

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2nd Assignment:  MU

I sold MU 180209P41 on 1/29 for a credit of $0.45.  With 11 days to expiration, the unexercised return on option (UROO) was 1.09%, the closed return on option (CROO) was 0.94%, and the annualized return on option (AROO) if I closed early at $0.05 would have been 31.08%.  At the time there was a 78% chance that the option would close OTM.  I sold the -0.2234 delta.  My break-even for the position is $40.56, including commission.

MU closed at $40.54, below the strike of $41, so the stock was put to me.

MU does not report earnings until Thursday, March 22nd, after the close, so there is nothing there to worry about in terms of impact.

Let's take a look at the expected range of MU for the next week:

Short Call bid:  1.07
Short Put bid: 1.67
Total:  2.74

Expected range: 37.80 to 43.28

My target is selling a call at the 43.50 strike or higher.

Here is the plot of "change in premium vs change in delta" for various strikes:

I've put the arrow on the 44 strike because you can see that at lower strikes, the blue dots are below this level -- reward / risk is improving, on a percentage basis, for the $44 and $44.50 strikes, relative to the $43 and the $43.50 strikes.

Yes, I acknowledge that I collect more premium at the $43 and $43.50 strikes, but it's at a higher delta, and this is a higher risk / lower probability that I'll be OTM.

The $44 strike has a delta of 0.163 as I write and a midpoint (premium) target of $0.27.

As from my analysis with AMAT, I am looking to ensure I have at least 20% AROO in the trade.  With 5 days to expiration,  20% * 5 / 365 = CROO (Closed Return on Option) = 0.27%

So, any premium that results in me getting at least 0.27% in 5 days is worthy of my efforts.

My cost basis on the stocks is my break-even * 100 shares, or $4,056.

0.27% of my cost basis is $10.95, or $0.11/share.  Because there is a $1 commission in here I'll add another $0.01 to show I need at least an option premium of $0.12 to make this 20% minimum.  This is well above the $0.27 midpoint at the $44 strike so this delta works.

A final check is to ensure that there is open interest (OI) at the strike.  The $44 call in MU has 22,054 contracts as I write this.

The order will be STO 1 MU 180216C44 Limit $0.25 DAY.

MU Trade Analysis

If the price of MU rises above $44, I'll make $300 from the stock appreciation (put to me at $41 and called away at $44), plus the premium from the CSP of + $44 (incl comm), plus this CC premium of $24 (premium of $25 less $1 comm), so $68 in total premiums, for a total of $368.  The original amount invested was $4,100 on 1/29 (cash secured put), so for 19 total days the annualized return is (368/4100) * 365/19 = 172%.

If the price of MU is above $41 but below $44 then I'll still have the amount above $41 as paper profit plus the banked premium of the CSP ($44 incl comm), plus the banked CC premium of $24 (incl comm).  The call will expire worthless and I keep the premium.  The AROO for this premium ($24 incl comm) and amount tied up ($4,100) is 42.73% (24/4100*365/5).I could sell the shares on the market to collect the paper profit or I could sell another call against the underlying.

If the price of MU is below my new break even of $40.56 - 0.24 = $40.32 or lower I'll still be underwater (but owning a quality stock).  I keep all the premiums and will sell another call to further lower my basis.

~~~~~~~~~~~~

3rd Assignment:  SQ

I sold SQ 180209P41.5 on 1/29 for a credit of $0.30.  With 11 days to expiration, the unexercised return on option (UROO) was 0.73%, the closed return on option (CROO) was 0.61%, and the annualized return on option (AROO) if I closed early at $0.05 would have been 20.13%.  At the time there was a 88% chance that the option would close OTM.  I sold the -0.131 delta.  My break-even for the position is $41.21, including commission.

SQ closed at $39.75, below the strike of $41.50, so the stock was put to me.

SQ does not report earnings until Tuesday, February 27th, after the close, so there is nothing there to worry about in terms of impact.

Let's take a look at the expected range of MU for the next week:

Short Call bid:  1.35
Short Put bid: 1.45
Total:  2.80

Expected range: 36.90 to 42.55

My target is selling a call at the 43 strike or higher.

Here is the plot of "change in premium vs change in delta" for various strikes:

I've put the arrow on the $43 strike because you can see that at lower strike of $42.50, the blue dot is below this level -- reward / risk is improving, on a percentage basis, for the $43 and $43.50 strikes, relative to the  $42.50 strike.

Yes, I acknowledge that I collect more premium at the $42.50 strike, but it's at a higher delta, and this is a higher risk / lower probability that I'll be OTM.  I do not mind holding a quality stock like SQ.

The $43 strike has a delta of 0.2179 as I write and a midpoint (premium) target of $0.45.

As from my analysis with AMAT and MU, I am looking to ensure I have at least 20% AROO in the trade.  With 5 days to expiration,  20% * 5 / 365 = CROO (Closed Return on Option) = 0.27%.

So, any premium that results in me getting at least 0.27% in 5 days is worthy of my efforts.

My cost basis on the stocks is by break-even * 100 shares, or $4,121.

0.27% of my cost basis is $11.13, or $0.12/share.  Because there is a $1 commission in here I'll add another $0.01 to show I need at least an option premium of $0.13 to make this 20% minimum.  This is well above the $0.45 midpoint at the $43 strike so this delta works.

A final check is to ensure that there is open interest (OI) at the strike.  The $43 call in SQ has 3,681 contracts as I write this.

The order will be STO 1 SQ 180216C43 Limit $0.40 DAY.

SQ Trade Analysis

If the price of SQ rises above $43, I'll make $150 from the stock appreciation (put to me at $41.50 and called away at $43), plus the premium from the CSP of + $29 (incl comm), plus this CC premium of $39 (premium of $40 less $1 comm), so $68 in total premiums, for a total of $218.  The original amount invested was $4,150 on 1/29 (cash secured put), so for 19 total days the annualized return is (218/4150) * 365/19 = 101%.

If the price of SQ is above $41.50 but below $43 then I'll still have the amount above $41.50 as paper profit plus the banked premium of the CSP ($29 incl comm), plus the banked CC premium of $39 (incl comm).  The call will expire worthless and I keep the premium.  The AROO for this premium ($39 incl comm) and amount tied up ($4,150) is 68.60% (39/4150*365/5).  I could sell the shares on the market to collect the paper profit or I could sell another call against the underlying.

If the price of SQ is below my new break even of $41.21 - 0.39 = $40.82 or lower I'll still be underwater (but owning a quality stock).  I keep all the premiums and will sell another call to further lower my basis.

~~~~~~~~~~~~

So, that's the plan going into next week.  Whether it works out is for all of us to see.

If you see anything wrong in my calculations, please let me know.  I think I have all of the bugs out of the spreadsheet that I used, but ya never know until others look at it.

~~~~~~

As with all my ramblings, you are responsible for your own investment decisions and I am not.  Please do your own diligence, and please take ownership for your actions.

Regards,

pgd