Short Put Options: Effective Trade Management Methods

Introduction:

A short put option strategy is when a trader sells or writes a put option on a security, it is known as a short put. By collecting the premium associated with a sale in a short put, the idea behind the short put is to profit from a rise in the stock\’s price. As a result, the option writer will lose money if the price drops. The method of controlling the risk involved in writing (selling) a put option is known as short put management. The goal is to lower the risk of losing money if the stock price drops below the put option\’s strike price.

Notations to Consider:

S = Stock Price
K = Strike Price
Date: Month and Day to expiration
STO = Sell to Open
STC = Sell to Close
BTC = Buy to Close
BTO = Buy to Open
SP = Short Put Option
LP = Long Put Option
SC = Short Call Option
LC = Long Call Option
DTE = Days to Expiration
DIT = Days in Trade
DCA = Dollar Cost Averaging
# SHARES = Number os long shares once Short Put is assigned.
SCB = Shares Cost Basis

Short Put Options Management Types:

1. Close the entire position (BTC)

2. Roll Out (Different Date and the same Strike Price)

3. Roll Out & Down (Different Date and Different Strike Price)

4. Roll Out & Decrease # Contracts

5. Increase Position to Decrease Basis Costs (DCA)

6. Take Assignment and Manage as a Covered Call Position

7. Take Assignment on Half of the Contracts and Manage the Remaining

8. Roll Out and Buy Long Put Options to Hedge

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Short Put Options Management Types:

1. Close the entire position (BTC)

2. Roll Out (Different Date and the same Strike Price)

3. Roll Out & Down (Different Date and Different Strike Price)

4. Roll Out & Decrease # Contracts

5. Increase Position to Decrease Basis Costs (DCA)

6. Take Assignment and Manage as a Covered Call Position

7. Take Assignment on Half of the Contracts and Manage the Remaining

8. Roll Out and Buy Long Put Options to Hedge

Short Put Options Management Examples:

#1: Close the entire position (BTC)

The simplest option is to simply close out the entire position, regardless of profit or loss. However, because this document is about trading management in this case we will be closing the position for a loss.

Closing a Put Option at a Loss: The stock price of XYZ traded at $55 on 01/01/22, and you sold a Short Put option with a strike price of $50 expiring on 30/01/22. Because the stock price is below the strike price of $50 and you sold a put option with a $50 strike price, the option is in-the-money. In this case, you would have to buy the stock for $50 and sell it for $45, incurring a loss of $5 per share. You would settle the trade by repurchasing the put option at the current market rate in order to reduce your losses.

How to Sell a Put Option at a Profit: Assume the stock price is $60 and you sold a put option with a $50 strike price. This indicates that the option is out-of-the-money since the stock price has risen above the strike price. You can just let the option expire worthless in this situation since the option buyer is unlikely to exercise the option. You would make a profit by doing this since you would keep the premium that you earned when you sold the option.

Note: In relation to stock options, I hardly ever close out trades that are trading for a loss. Because I only sell options on companies whose stock I intend to hold for a long time, option 1 is essentially out of the question for me.

#2: Roll Out (Different Date and the same Strike Price)

In this example, the stock price is $45, and you have sold a put option with a $50 strike price. This indicates that the option is in-the-money because the stock price is lower than the strike price. In this case, as the option seller, you would have to purchase the stock at $50 and sell it at the current market price of $45, incurring a loss of $5 per share. Rolling the put option might be a smart idea in order to maintain the dream, as we say options sellers:

Selling the existing put option (BTC): It will allow you to close the open position by repurchasing the put at the current market rate.

Purchase a fresh put contract (STO): Invest in a fresh put contract with further expiration date with a higher strike price. You might select a striking price of $45 (ATM options it is possible) as an illustration.

Original Trade:

Date: 01/01/20

Expiration Date: 30/01/20

S = $55

STO = 5 Contracts @ $50 SP Strike Price

# Contracts: 5

DTE: 30 Days

Trade Management:

Date: (30/01/20)

S = $45

BTC = 5 Contracts @ $50 SP Strike Price for $1.75 ($875 Debt)

STO = 5 Contracts @ $50 SP Strike Price for $1.97 ($985 Credit)

Net Credit: $(935 – 875) = $110

New DTE = 25/02/22

Note: This is the simplest way for a credit put management possible, when we just close the original position and reset a new expiration date keeping the original position intact.

#3: Roll Out & Down (Different Date and Different Strike Price)

Original Trade:

Date: 01/01/20

Expiration Date: 30/01/20

S = $55

STO = 5 Contracts @ $50 SP Strike Price

# Contracts: 5

DTE: 30 Days

Trade Management:

Date: (30/01/20)

S = $45

BTC = 5 Contracts @ $50 SP Strike Price for $1.75 ($875 Debt)

STO = 5 Contracts @ $47.5 SP Strike Price for $1.79 ($895 Credit)

Net Credit: $(935 – 875) = $20

New DTE = 25/02/22

Note: When we are able to lengthen the duration while also lowering the strike price, this is one of the best-case scenarios possible when it comes to keeping the dream alive and decreasing risks.

#4: Roll Out & Decrease # Contracts

Original Trade:

Date: 01/01/20

Expiration Date: 30/01/20

S = $55

STO = 5 Contracts @ $50 SP Strike Price

# Contracts: 5

DTE: 30 Days

Trade Management:

Date: (30/03/20)

S = $45

BTC = 5 Contracts @ $50 SP Strike Price for $1.75 ($875 Debt)

STO = 3 Contracts @ $50 SP Strike Price for $3.07 ($921 Credit)

Net Credit: $(935 – 875) = $46

New DTE = 25/02/22

Note: Management # 4 can also be a great way to decrease risk. Although we are not decreasing the strike price value, we are decreasing the numbers of contracts, which pretty much work in the same way when it comes to decreasing risk. It\’s also vital to keep in mind that if we need to go further back in time to gather more time value to make up for the difference in the number of contracts, we might be obliged to do so. But in this case we have reduced by 40% the number of contracts (Risk for this trade) and as well as capital requirement for this trade and also buying more time in order to keep the dream alive and for the stock to recover.

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#5: Increase Position to Decrease Basis Costs (DCA Dollar Cost Averaging)

Original Trade:

Date: 01/01/20

Expiration Date: 30/01/20

S = $55

STO = 5 Contracts @ $50 SP Strike Price

# Contracts: 5

DTE: 30 Days

Trade Management:

Date: (10/03/20) (Following Management #4)

S = $45

BTC = In this case we don’t BTC, we are just adding to the original position to lower our basis costs (DCA)

STO = 3 Contracts @ $45 SP Strike Price for $1.842 ($921 Credit)

New Strike Price Cost Basis: $((50 + 45)/2) = $47.5

Note: After we complete management number 4, this trade management strategy can be fantastic because we have already released some capital from management number 4, which can be deployed back to management number 5. In addition, the new three put position can also be sold in different expiration.

#6: Take Assignment and Manage as a Covered Call Position

Original Trade:

Date: 01/01/20

Expiration Date: 30/01/20

S = $55

STO = 5 Contracts @ $50 SP Strike Price

# Contracts: 5

DTE: 30 Days

Trade Management:

Date: 25/02/20

# Shares = 500

S = $45

STO = 5 Contracts @ $50 SC Strike Price for $0.75 ($375 Credit)

Shares Cost Basis = $(45 – 0.75) = $44.25 per share.

Note: It is crucial to keep in mind that this option only makes sense if we believe the stock price won\’t deviate significantly from the $45 assigned strike price. If the stock does, we won\’t be able to sell calls against it because the available options won\’t have enough premium to make them worthwhile. Also important to remember that holding long stocks will require more capital then short put options.

#7: Take Assignment on Half of the Contracts and Manage the Remaining

Original Trade:

Date: 01/01/20

Expiration Date: 30/01/20

S = $55

STO = 5 Contracts @ $50 SP Strike Price

# Contracts: 5

DTE: 30 Days

Trade Management:

Date: (30/01/23)

S = $45

BTC = 2 Contracts @ $50 SP Strike Price for $1.75 ($350 Debt)

STO = 2 Contracts @ $45 SP Strike Price for $1.88 ($376 Credit)

Put Net Credit: $(935 – 875) = $46

STO = 3 Contracts @ $50 SC Strike Price for $0.67 ($2.01 Credit)

Shares Cost Basis = $(45 – 0.67) = $44.33 per share.

Note: If we are bullish on a particular stock for the long term and a stock that pays dividends, this management could be very good. One of the trade management methods mentioned above may be used to manage the remaining put options.

#8: Roll Out and Buy Long Put Options to Hedge

Original Trade:

Date: 01/01/20

Expiration Date: 30/01/20

S = $55

STO = 5 Contracts @ $50 SP Strike Price

# Contracts: 5

DTE: 30 Days

Trade Management:

Date: (30/03/20)

S = $45

BTC = 5 Contracts @ $50 SP Strike Price for $1.75 ($875 Debt)

STO = 5 Contracts @ $50 SP Strike Price for $3.07 ($1535 Credit)

Net Credit: $(1535 – 875) = $660

Note: In this case, we can use the credit received of $660 to buy some Long Put options to hedge the position.

BTO = 5 Contracts @ $30 LP Strike Price for $1.30 ($650 Debt)

Total Net Credit: $(660 – 650) = $10

FAQ

Q: What is a short put option?

A: A short put option refers to selling a put option, which means the seller has the obligation to buy the underlying stock at the strike price if the buyer decides to exercise the option.

Q: What are some common short put option trade management methods?

A: These can include rolling the put to a later date, adjusting the strike price, or closing the position if the risk/reward ratio becomes unfavourable.

Q: What does \’rolling\’ a short put option mean?

A: Rolling a put option involves closing the current position and opening a new one at a different strike price or expiration date. It\’s a way to adjust your position in response to market movements.

Q: What factors should be considered in short put option trade management?

A: Factors to consider include the current market price of the underlying, the remaining time to expiration, and the current risk/reward profile of the position.

Q: Can short put options result in losses?

A: Yes, if the price of the underlying stock drops significantly, a short put position could result in substantial losses because the seller has the obligation to buy the stock at the strike price, which could be much higher than the market price.

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