Smooth Sailing With Options

Been thinking about a way to sell and then protect calls (or puts) when you are underwater.  (I’ve talked about this before, but lately have been trying it as an experiment.)  Say you get assigned and have to buy the stock at $200 but it goes on down to $170.  So then you sell a call a week out using the 80% POS guideline at a strike of $180, below your acquisition cost, and make $1.00 in premium.  But because you’re underwater, you don’t want to buy the stock if you were to get assigned.  To avoid that, you place a stop order at $3.00 for the call.  Triple what you were paid for it.  That way if the stock climbs more than you expect, you’ll get bumped out at a loss, but at a known loss.  You made $1.00, the stop order cost you $3.00, so your loss is $2.00 for a loss of $200 per contract.  But 100 shares of IWM, bought at $200 and assigned at $180, is a realized loss of $2000.  I’ll take a $200 loss over $2000 any day.  This does set you up to get bumped out now and then on normal fluctuations in the market, but as long as you have more successes than failures by a two to one ratio, you are ahead, and you are protected.  This trick is not going to be used often, the only time this is useful is when you are deeply underwater.  But I find myself in this situation now and then.  I’ll get assigned at one strike and then have to wait for it to recover before I can sell more calls as I don’t want to take the chance of being assigned below my cost basis.  This trick allows me to continue selling while I wait for the price to move in the right direction, while also preventing me from getting assigned deeply underwater.

This can be adjusted too.  I did one contract at a time several times over the last couple of months at twice the premium, three times, and again at four times the premium.  Three times seems to be the sweet spot.  You’ll want to cancel this order if it gets close and it’s also the day before expiration, or the day of.  At that point you have to look at rolling it. 

You don’t have to actually put the order in, you can just watch it closely or set alerts to warn you.  The problem with that is if we get a large drop it can blow past your stop and then you are stuck in the contract.  So if I think there’s any chance I’ll get assigned I put in a GTC stop order and just keep an eye on it.

Lastly, this practice might be a good little bit of insurance for the future.  The market went up something like 26% this year AND last, and it’s up 81% in the last five years.  Those who think that’s going to continue, well let’s just say I don’t think anyone knows that.  The “temporary hardships” that the new administration has promised are unknowns.  So this practice, with a stop order at a wide four times the premium, might be a practical way to keep from getting slammed deeply underwater on a large drop over a short time.  Will be experimenting with that as well.
It’s an art!

And the numbers just keep going up: