We love selling overpriced puts (on liquid stocks with tight spreads) with bullish patterns. Many novice traders like to swing for the “home run” and buy out-of-the-money calls with unlimited potential (or even the equity itself) since the upside is unlimited.
When is it Better to Sell Puts Versus Buy Stock?
However, it is prudent to first analyze the various reward-risk setups using options before taking the trade. Let’s look at the math on NAT, a beat up oil shipping stock.
Below is the daily chart of NAT, also showing the elevated spike in implied volatility from TOS (IV Rank of 75%):
The stock has been crushed, selling off from $16 to $10 in three months. Although not shown, it is on major support (prior low) on the weekly and monthly charts. Below is the hourly chart of NAT.
Two days ago it had a very bullish gap up. Although it has had a questionable deep retracement, it is approaching the gap fill support area a second time and possibly setting up a “W Formation” double bottom. An aggressive trader can enter once it trades over a prior hourly bar’s high (and provided the $10 support area first holds).
Selling Puts/Spreads on NAT
NAT is currently trading at $10.12. An investor could purchase 1,000 shares for $10,120; however, let’s compare that to selling the spiked Oct puts. The $10 puts are considered “at-the-money” (ATM). One could sell a 10-lot of the Oct 10 puts for $.70/share, generating $700 in premium. This would give a cost basis of $9.3/share if assigned, a 7% discount to the stock buyer (significantly higher if annualized).
Selling a Oct 10/8 put spread for $.50/share (or $.52 if filled at mid-point) would generate $500-$520 on a 10-lot and limit the risk to $1,500 (the difference in strike prices and premium received), a more conservative approach. I have been slowing scaling into both trades although a more conservative entry because of the deep retracement would be to wait for NAT to trade above a prior day’s high.
Below are the Oct put prices for the 7-10 strikes:
The downside to the put seller versus stock buyer is that the premium received of $700 is the maximum gain to the option seller, whereas the stock buyer has unlimited gain.
Pigs Get Slaughtered
My response to that view when selling overpriced premiums like this is, SO WHAT!!?? There are 50 days to Oct expiration. As a prudent trader (not a “pig,” as they get slaughtered over time), I would love making 7% in less than two months (annualized over 45%) on a stock which moves SIDEWAYS OR UP — I will gladly give up any further upside. And if it goes down and you don’t mind being assigned, you are buying it at wholesale – a 7% discount! My stop loss is 20 cents under support for all trades.
NOTE: With the bullish pre-market activity in an oversold gold sector, we will be looking for bullish put spreads on gold and silver stocks today.
Happy trading! If you have any questions or comments, please e-mail Dan Gibby at Dan@gregcapra.com
