Selling naked puts and calls – managing an ugly trade into a winner

Predicting the stock market
This is a chart a user named KubaW created and posted on StockTwits. I asked him based on what he believed that what he drew would rally happen and that his drawing was just a coloring book for kids and had no predictive value. My comment sparked rage from him and his ass-lickers who typically patted him on his shoulder what a nice chart he created.He called me an uneducated ignorant loser and never provided an answer.
 
 

Recently, I encountered a fiery discussion on StockTwits website with a few market predictors and weather casters (as I call them). If you follow me on this blog or in our trading Facebook group you know that I no longer try to predict the market or stock movement as I consider it foolish and ineffective.

You can read my opinion about market forecasting in a Strategy section. No matter what the market or your stock did in the past will not guarantee nor predict what it will do in the future. All those predictors do is just guessing. And they always have only 50% chance of being right. So why bother with an extensive charting analysis to just achieve 50% chance of being, right?

 

Let me share a story with you:

The semiretired chairman of the board of the brokerage firm was a long time trader with nearly 40 years of experience in the grain pits of the Chicago Board of Trade. He didn’t know much about technical analysis, because he never needed it to make money on the floor. But he no longer traded on the floor and found the transition to trading from a screen difficult and somewhat mysterious. So he asked the firm’s newly acquired star technical analyst to sit with him during the trading day and teach him technical trading. The new hire jumped at the opportunity to show off his abilities to such an experienced and successful trader.

The analyst was using a method called “point and line” developed by Charlie Drummond. (Among other things, point and line can accurately define support and resistance.) One day, as the two of them were watching the soybean market together, the analyst had projected major support and resistance points and the market happened to be trading between these two points. As the technical analyst was explaining to the chairman the significance of these two points, he stated in very emphatic, almost absolute terms that if the market goes up to resistance, it will stop and reverse; and if the market goes down to support, it will stop and reverse. Then he explained that if the market went down to the price level he calculated as support, his calculations indicated that would also be the low of the day.

As they sat there, the bean market was slowly trending down to the price the analyst said would be the support, or low of the day. When it finally got there, the chairman looked over to the analyst and said, “This is where the market is supposed to stop and go higher, right?” The analyst responded, “Absolutely! This is the low of the day.” “That’s bullshit!” the chairman retorted. “Watch this.” He picked up the phone, called one of the clerks handling orders for the soybean pit, and said, “Sell two million beans (bushels) at the market.” Within thirty seconds after he placed the order, the soybean market dropped ten cents a bushel. The chairman turned to look at the horrified expression on the analyst’s face. Calmly, he asked, “Now, where did you say the market was going to stop?…

Trading in the zone: Master the market with confidence, Mark Douglas, p. 76 – 77

 

The goal is not to predict where the market will go or what your stock will do, but always know what you will do.

And that was the deal with a few predictors on StockTwits when I told them that all they were doing with all their charting was just creating comic books.

Whining Baby And this caused them to steam like an old locomotive, calling me names, calling me ignorant, stupid, and of course blocking me. There was even one user with a username @Nickvee14 who went into a rage of hysteria, calling me a fraud and liar when he saw my trading results.

This guy has in his profile that he was a: “Former Owner of a Stock Brokerage firm 17 years on Wall St Managed High Net worth clients primarily . Now just trading for myself my comments are not advice , it is just my opinions”.

Read his description again. He reveals who he really was. He just managed wealthy clients. So all he did he was just a seller of lukewarm water. But being an owner or manger of a brokerage firm will not make you a good trader. And his rage confirms it.

Here is how he reacted to my trading results which you can see in My Trades & Income section of this blog.

Yes, all the trades on that page in the table are winners, all show green and positive outcome. And that caused our so called “former broker” going on a rage that I was a fraud and liar. Here is his raging:

 
Nickvee Raging
Click to enlarge and enjoy a furious reading.
 

Honestly, I have never seen such anger, rage, and hysteria so far and it was surprising to me.

What this person evidently failed to understand is that what you see in my results table is the result of my trade management. My goal with every trade is to manage every losing trade into a winner. This person was boasting about his trading, being a CEO, and predicting skills, but he was also revealing that he wasn’t a good, consistent trader at all.

Does it mean that since I had 100% winners shown in that table that I have always picked winners?

Far from true!

Many of the trades actually turned into losers right after I opened them! Many of those trades gave me a hard time and headache.

But as I said at the beginning of this post, it is not important to know what your stock will do, but what you will do when the stock goes against you. I no longer have to spend hours creating predictions, beautiful charts, constructing reasons, or forecasting next move, to trade successfully.

Successful traders know this. Losers spend hours convincing themselves about the next stock or market move.

When I was learning trading options, my mentor, a successful trader, taught me that it was important to make money even when you had a losing trade and everybody around you was losing money and panicking.

So how do you turn a loser into a winner?

I would like to share with you a history of one of my trades which went bust the next day and that there are strategies how you can play with your position to turn it into a winner. I used Seagate Technology (STX) as my underlying and it all started as a simple put selling trade. Was I predicting the next move of the stock? Absolutely not! It would have been worthless anyway as the stock later moved the way no one would had predicted unless you knew before hand what the company would report.

 

 · Initial trade – sell naked put

 

In April I sold a naked put with 33 strike. It looks all good and great. The stock was at the support and about to kick up again. Look at the chart at the time of opening the trade:

 
STX 01
 

However, the next day the stock plummeted to 27.11 a share. Ouch. What a blow.

 
STX 02
 

What do you do when something like that happens to you?

 

 · Trade repair #1 – collecting more premiums by selling naked calls

 

First of all, stay calm. This is not the end of the world. Unless the company is going out of the business, which STX didn’t, there is no need to panic. When your position plummets, you want to start collecting more premiums to offset your paper loss so you can get out eventually with a smaller loss.

But you can do this only if you have enough cash in your account so you do not get hit by a margin call when rolling more trades. So your next steps must take into account your size, risk level where you feel comfortable.

I immediately sold a naked call with 30 strike.

People, brokers, investors, and even some brokers will tell you that naked calls are extremely dangerous and risky. Don’t believe them. The have no clue what they are talking about. A naked call is dangerous only to an amateur trader or broker who is just selling some product to his clients and have no clue how they can be played safely. It is the same as claiming that the guns are extremely dangerous. Yes they are. They are dangerous in hands of idiots. Same goes with naked calls.

Why: This allowed me to collect more premium in case the stock stayed lower for longer time. I was now playing a downside of the stock.

 

 · Trade repair #2 – roll busted puts

 

At the same time when I was selling my naked calls I rolled my exiting 33 strike put down to 32 strike. It was simple. I bought back my old 33 strike put and sold a new 32 strike with longer expiration day. And it doing so, I collected another nice premium (it was another 0.80 cents or $80 dollars on top of the premium I collected on my original trade).

Why: By rolling I was lowering my strike so now the stock doesn’t have to recover all the way up to 33 a share but only to 32 a share. Today, as of this writing, we are almost there. We almost recovered. But if we do not recover, I am prepared to roll again when times come. I have a plenty of time and I can wait. The new trade has expiration in December 2016 and if we do not recover by December I will roll down and away in time again. I may roll down to 31 or even 30 strike. We will see.

The next benefit of this move was that I collected another premium to offset any potential losses. But there will not be any losses at the end.

You may ask why I was rolling into December blocking my margin for so long. Well when the stock plummets like this you want to avoid early assignment. Moving your trade 250 days away will do the job as no one sane would early assign such long trade unless they know something such as company going to bankruptcy for example.

 

 · Trade repair #3 – protect your naked calls

 

Unfortunately, the stock started recovering from the fall. It went up from $25.59 a share all the way up to $27.34. This started to be dangerous to my naked call with 30 strike. So, I was thinking what are my options. I could let it run and roll the calls higher and away in time, or buy 100 shares covering my calls and making it a covered call trade.

I decided to buy 100 shares at 27.29 a share.

Why: At the time it seemed as a good move. The stock was recovering very fast and if it managed to expire in the money I would collect a very nice profit on the stock and on the calls.

Yet the market had different plans.

 

 · Trade repair #4 – collect more premiums

 

As the stock was recovering I sold another naked put at 26 strike to collect even more premium.

Why: I wanted to reach a position when you can play this trade with house money if it went even worse. But it went great, the stock was recovering and I had all my trades covered.

But then an earnings report came out and the stock plummeted again. This time from $27.40 down to $20 and a few days later to $18.42. That wasn’t great. But again I wasn’t panicking or freaking out. I take these trades as another opportunity although it blocks your money and slows down your future earnings. But I take this game that I want to be a consistent winner and not a racer. If it happens and I have to wait for my money 200 days instead of 19 days I am fine with it. It happens.

 
STX 03
 

 

 · Trade repair #5 – grab profits, short more, and collect more premiums

 

As the stock plummeted more, I could close my 30 strike calls for 50% credit and immediately sold new calls at 28 strike. These new calls expired the very next day for a full profit.

Since the new calls expired the very next day (I was in this trade for only 1 day, 469.29% annualized return), on Monday I could sell a new covered call at 23 strike. At the very same time I rolled my 26 strike put down to 24 strike and collect more premiums.

When the stock reached $18.40 a share and started reversing I sold a new naked put with 18 strike. The $18.42 seemed to be the bottom and the stock continued marching higher again.

This allowed me to close my 18 strike puts for 50% credit profit and open a new naked put trade with 19 strike to collect more premiums. I could close 19 strike puts later for 50% credit.

As of now I collected $1,763.00 dollars in premiums and had the following open trades:

 
– (1) short naked put 32 strike (the rollover of the original 33 strike put) and still ITM
– (1) short naked put 24 strike (the rollover of the original 26 strike put) and still ITM
– (100) shares of STX at $27.29 a share and still in a loss
– (1) covered call at 23 strike

 

 · Trade repair #6 – manage your calls when under water

 

When you get assigned to a stock and you start selling covered calls against it when your stock is deep under, like in my trade when I bought shares at $27.29 and stock was trading at 20 or 21, you will not be able to sell a call at 28 strike for example to get out of your shares with profit. So you have to sell closer to the money (as I did and sold 23 strike).

But doing so, you are taking a risk that if you get your calls assigned you will be selling your stock at 23 a share while you have bought it at $27.29 a share. That would be a huge loss which you do not want.

When you are in a such situation you have to manage actively your calls to avoid it. It may happen if you get assigned early (that’s why you want to be selling longer term calls so assignment is unlikely), and it would be unfortunate if it happened, but that’s the part of the game.

So when the stock started approaching my 23 strike and it even exceeded it in some days, I rolled my 23 strike calls higher to 25 strike. This got me higher to my original stock purchase price and I was ready to do it again as long as I got the strike price above $27, ideally to 28 strike at which level I would let my stock be called away.

 

 · Trade repair #7 – rolling and new trades to improve the trade

 

Mr. Market had a different opinion and didn’t want to give in so easy. These days the company issued a preliminary earnings results which exceeded Wall Street’s expectations. The stock jumped 13% overnight and finished almost 20% by the end of the next trading session. It had a few positives and one negative.

My 24 strike naked put was no longer in the money.

But my 25 strike covered call was in the money and at the level I didn’t want assignment.

I took a look at the option chain to again evaluate my options to fix this. Obviously I didn’t have to do anything with my puts, but I needed to do something with my calls. I didn’t want assignment at 25 a share while I bought the stock at $27.29 a share although I collected more than $2,000 dollars in premiums so I could afford taking a loss on the stock. But why taking a loss when you do not have to.

 

 · Trade repair #8 – converting calls into puts and selling more calls

 

In situation like this when you get your calls ITM it is sometimes helpful to convert them into puts than keep rolling them higher. I reviewed what could have been done and I saw I could convert my 25 strike ITM calls into 32 strike puts and I moved them far away in time to collect better premiums and also get more time. I simply didn’t want to deal with those puts now, so I literally put them aside for later time to either roll them lower or let them expire if the stock moves higher by expiration.

Once I converted my calls into put I immediately sold already ITM 28 strike calls. These calls were above my stock purchase price of 27.29 a share so I could let them get assigned and close my trade for a profit.

My calls were assigned this weekend and I could sell my 100 shares for profit as well as profit on the covered calls.

During this time I managed my trades to finish as winners. Overtime I collected $2,615 dollars in premiums and I also collected $63 in dividends while waiting for assignment.

I ended up with the following positions:

 
– (1) short naked put 32 strike (the rollover of the original 33 strike put) and still ITM
– (1) short naked put 24 strike (the rollover of the original 26 strike put) now OTM and possibly set to expire worthless or be bought back for 50% credit profit
– (1) short naked put 32 strike (the conversion of the original 25 strike call) and ITM
 

So there are still trades which need my attention but I am confident that before they end I will be able to manage them into a winning trade. Lately, I also opened more new trades against STX and collected even more premiums and no matter what happens with the stock, I will manage it into a winning trade.

As you can see, I do not have to predict what the stock or the market will do. I do not have to be creating comic books of nice technical analysis charts and forecast the next move and misleading myself by false expectations and predictions which may not happen.

All I do is a simplistic method of determining a trend and then trading that trend. And if the trend changes use all tools available to respond to a new situation. It is a beauty of options that you have that flexibility that you can be rolling or reversing your trades to make it work. It is all about knowing what you would do instead of knowing what your stock or market would do.

And yes, there will be people out there who would be calling you names and spit their envy and anger on you when you tell them that what they do is futile and that you can do better without it like that whiny poor trader I showed you above.

Of course, you may doubt all I wrote above about the trade and my steps to fix it. But all my trades are posted live in our trading Facebook group and joining the group is free. You can follow my trades in the group and see for yourself that it really is possible to be a consistently winning trader. There are other traders too, posting their trades and you can follow them too.
 
 

“Truth is like poetry.
…and most people hate poetry.”
unknown author, somewhere in a Washington D.C. bar





6 responses to “Selling naked puts and calls – managing an ugly trade into a winner”

  1. Jeffrey Warren says:

    I’m doing exactly what you are doing. However, I’m only making 2000 a week with 300,000. You are using dividend growth stocks in case you get assigned – STX has a great dividend, what other stocks are you trading?

    Thanks

    • Martin says:

      I publish my trades on my Facebook page.

      Lately, with the market volatile I trade mostly SPX, when the market calms down a bit and I will be clear on its direction I will go back to trading options against stocks. As of now I only keep buying stocks for dividends using proceeds from options trading.

      Thank you for stopping by.

  2. Found you through Amber Tree Leaves.
    With your methodology nobody ever loses money. Because you can always keep rolling down the naked put price and eventually the stock will recover and you grow yourself out of the hole. So, I’m not surprised that some folks can generate high hit ratios.
    But you could run out of margin cash in the process. With a toy account of a few thousand dollars, of course, you can always chip in a few thousand additional dollars. But would/could you run your account at 100 times your current size? Would you risk wiping out your entire trading account if the market corrects by 10-15% and you don’t have another $500k sitting around for you to move in again to grow yourself out of the hole? Of course, if you could generate 45% on $500k every year, you’d be golden. But watch that steamroller while picking up nickels!

    • Martin says:

      Hi, thank you for your comment.Yes you are correct, with this strategy you can theoretically roll as long as you become right again, but I usually try to apply other strategies to get out of the trade faster or even take a stock assignment and start selling calls. It is all about a trade management.
      As far as a draw down you need to have a good cash management in place so when the market gets down by 10% to 15% or even 20% you won’t get hit.
      To a question whether I would be trading 500k account? Probably yes as that would have me trading comfortable without stretching it out too much. With a current account of $40,000 making $5,000 a month is taking an enormous risk. Making $5,000 monthly with a $500k account it is possible and with a lot smaller risk.
      Would I be trading 1 million account? Probably not. For that I would only use amount I feel comfortable to trade with and the rest would go into dividend stocks.
      Thank you for stopping by!

      • Thanks for the reply. I was actually wondering if at the larger scale you would scale up the entire portfolio (including all options positions) as well. Say, if you run the $40,000 account with $5,000 return target, would you then run the $500,000 account at $62,000 (=5000/40000*500000) return target? With the significant downside risk all the way up to wiping out the account? It’s easy to replenish a $40k account in case something goes wrong (and it does occasionally as you mentioned with your SPX options), but at $500k it’s not so easy anymore.

        The reason why I’m asking is that my own portfolio has reached a size where I have to be pretty cautious about the downside. So I want to be robust to 3, even 4 sigma events without having to replenish any margin cash.

        Anyway, nice blog. Good luck!

        • Martin says:

          No, I wouldn’t be scaling up. I am actually against compounding returns as it can really damage you and your account. So I have a goal of what I want to achieve and then trade the entire account to achieve that revenue and once I achieve it, I stop trading for the season (month). So, for example, my goal is to reach $60,000 monthly income, withdraw $30,000 and reinvest the remaining $30,000. Then the entire account will serve that goal.

          If I have $1,000,000 account, I will be trading it to reach that goal of $60,000 dollars monthly income. With $1M account it would be 6% / mo. Doable? maybe, maybe not. But I will not be going up trying to make $100,000 monthly just because in the past when I was trading $40,000 I made $6,000. No, in this case I have a full dollar target and once I reach it, I am done with trading for the month.

          I look at the money sitting in my account as a machine, tool, a factory which is manufacturing new money. You do not want to damage your machine just because you overheated it, or overran it. Like when you take a standard motor, connect VFD on it and over-speed it beyond its standard rpm. The motor will burn.

          So if you have a substantial amount of money, analyze what you can comfortably do with it per month, or per day, or per whatever period you want, and start trade it to reach that goal and do not compound. My goal is to reach $12,000 per month, take out $6,000 per month and re-invest the rest. I would increase that amount after I can comfortably afford it without jeopardizing the account. From my own records, my $40,000 account can comfortably reach $2,000 without stretching it and overtrading. To reach my goal I need to have at least $500,000 in my account to trade comfortably and have my monthly income.

          Thanks for stopping by and commenting! Good luck to you too!

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