Smooth Sailing With Options

Been running another experiment these last few months while IWM has been so high and I’ve been mostly sitting it out.  This experiment is looking for a way to keep trading when I’m underwater, some way to reduce the risk of assignment above my last one.  I was last assigned at 185 when I had calls out, so I’m all in cash.  If I sell puts at these levels with IWM around $205 and I get assigned at say $200 and then IWM goes back to $185, I’ll be in the hole $15 a share.  No thanks.  Which is why I’ve been sitting on cash for several weeks now, waiting on the market to deflate.  So let’s say it doesn’t deflate and holds and even goes higher.  I still don’t want to get assigned at prices higher than $185 but I want to trade and bring in that weekly income.

There are three ways to work this one that I can see.

1:  Roll on the day of or the day before expiration.  That works IF IWM doesn’t move too far.

2:  Let the contract get assigned and then sell covered calls at or near the same strike in order to sell at close to the same strike you were last assigned at.  Same as above, that works IF IWM doesn’t move too far.

3:  Use a limit order to buy back your contract at some multiple of what you were paid for it.  This gets you out IF the price starts to drop and expires harmlessly if it doesn’t.  I have been selling puts at higher levels, like $200.  But to avoid getting assigned, as soon as I sell the put, I place a GTC limit order to buy to close at three times my premium.  If I sold at .50, then I put my limit in at $1.50.  Now if IWM moves down against me the option will go up in price and bump me out before I get assigned.  As the days pass time value lowers the price of the contract and this goes in your favor, while if IWM drops sharply it gets you out without risk of being assigned.

If I did not have the 3X limit order in and I was assigned at say $205, that’s twenty bucks from my current underwater strike of $185, times 100 shares, for a paper loss of $2000.00 per contract.

Since I sold my put at .50 and used a $1.50 limit to buy it to close, that cost me 100 times $1.50 or a cash loss of $150 per contract.

I’d generally rather take the risk of a $150 loss than a $2000 loss, even accounting for the difference between a paper loss and a cash loss.  And with any luck, this will only happen occasionally.  Once you have made three trades without the limit order getting tripped you have covered the cost anyway, so after that, all gravy.

The drawback to #3 is that your order could get filled on a down day, then IWM could pop back up and so your contract would have been ok anyway.  Rats!

I tried using twice my premium instead of three times, but those got tripped too many times.  Daily variability got me too many times.  Three times seems to be better, while four times the premium has been inconclusive so far.  At four times the premium, IWM can still get close to the strike and then you can roll.  Or IWM can move below your last assignment and you get assigned anyway.  You have to watch closely the last few days of the contract and adjust as needed.

So there is no golden rule.  Once again, this is an art, and a science.  So what I’ve been doing lately is selling a put at around 80% POS, placing a 3X limit order then watching it and canceling it if need be so I can roll.  If and when IWM drops back to 185 and I get back in I won’t have to do this and I’ll go back to my usual.

Happy trading!