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Rolling Out In-The-Money Cash-Secured Puts

Introduction

Selling cash-secured puts is a topic I've written about extensively since starting the Option Generator website. The cash-secured put involves writing (selling) a put option and simultaneously setting aside enough cash to buy the stock. The strategy can be used in one of three ways:

  • Generate income from premiums (you do not want exercise)

  • Purchase a stock for your portfolio “at a discount” (you would like exercise)

  • To be used to enter a covered call position (either exercise or non-exercise will work well)

Depending on what your goals are, we're going to respond differently to a situation where the put strike is in the money. Let's take a look at a fictive, hypothetical trade to elucidate the mathematics behind the exit strategy called 'Rolling On/Near Expiration' based on a 42-day expiration period. This serves as a perfect example for premium members who have access to the spreadsheets.


Opening Trade

Let's summarize the following trade setup:

  • Price of the stock "X": $62

  • Short put strike: $60; the strike is out-of-the-money with $2 per share of downside risk protection of the time value profit

  • Number of contracts sold: 1

  • Premium received: $300 per contract, resulting in a breakeven of $57. The premium is all time value. As long as share value does not depreciate below $57 by expiration Friday, the trade remains profitable.

  • The amount of cash we have to come up with to meet a possible future stock transaction is $5700 per contract.

  • If share value remains above the strike price by expiration Friday, we generate a return of 5.00% which annualizes out to 52.81%.

(Source: Option Generator's Spreadsheets)


Final Return For The Trade

At the end of the contract period, shares of stock "X" were trading at $58.25, higher than the breakeven level of $57.00 so the trade remains PROFITABLE, although we have a loss on the stock side if we take no action and allow assignment. If we let the strike expire in-the-money, the shares will be put to us at $60.00, however, we've generated a cash premium of $3.00 per share. As a result, our adjusted cost-basis is $57 per share if we get the 100 shares. We had initial downside risk protection of $200 per contract, but now, the strike is in -the-money and has therefore intrinsic value. The cost to buy back the short put is $180 per contract of which $7 or 2.78% is extrinsic or time value. If we allow assignment, our final return for that 42-day period is 2.08% or 19.62% annualized. We can then sell a covered call to lower our breakeven further, sell the stock or add it to our long-term buy and hold portfolio with the possibility of implementing the portfolio overwriting strategy.

(Source: Option Generator's Spreadsheets)


Rolling Out (Or Down) On/Near Expiration

As mentioned above, the cost to buyback the short put is $180 per contract. Now, let's say we don't want assignment but settle for an extra return/trade with that same underlying, stock "X". Let's focus on the $58 and $60 strike for the NEXT options cycle. We generate the following premiums for these two strike prices:

  • The $58 strike pays a healthy $3.90. This strike is lower than the initial one of $60, it's known as rolling out and down, because we want to play defense.

  • By selling the $60 put, we generated a $6 premium per share. This strike price is equal to the previous one, it's called rolling out.

(Source: Option Generator's Spreadsheets)


Rolling Out And Down

By rolling out and down to the next month, we generate another 3.50% for the next 42-day period. Please note that we use the previous strike price of $60 as our reference. If the chart technicals of the underlying and our own personal goals meet our system criteria, we can move forward with this trade. This type of trade fits into the framework of a more conservative risk tolerance. Remember that the stock has already been beaten down from $62 to $58.25, though, our trades remain profitable. Adding the previous premium received to the equation, our break even for the stock is now $60 - $3 (time value only) - $2.10 (net gain/(loss)) = $54.90


For an entirely new trade, the following calculations - which are obviously not linked to the rolling transactions - appear:

(Source: Option Generator's Spreadsheets)


Rolling Out

By rolling out to the next month, we generate another 4.08% for the next 42-day period (see screenshot above). Please note that we use the previous strike price of $60 as our reference. If the chart technicals of the underlying and our own personal goals meet our system criteria, we can move forward with this trade. This type of trade fits into the framework of a bullish/aggressive risk tolerance. Remember that the stock has already been beaten down from $62 to $58.25, though, our trades remain profitable. Adding the previous premium received to the equation, our break even for the stock is now $60 - $3 (time value only) - $2.45 (net gain/(loss)) = $54.55. Since the $60 put strike is in-the-money by $1.75 right from the beginning, we cannot count the entire premium as profit. If we don't evaluate the math appropriately, we are exaggerating our results. The calculator takes into account the amount that the strike can be in-the-money.


For an entirely new trade, the following calculations - which are obviously not linked to the rolling transactions - appear:

(Source: Option Generator's Spreadsheets)


If the price goes up to $60 or higher, we then fully pocket the intrinsic value component of the premium as well.

(Source: Option Generator's Spreadsheets)