I only started selling naked puts a few months ago, so my it is natural that my strategy is going to change. At first I thought I would only sell naked puts against dividend champions, but I quickly learned that the premiums were not enough to make it worthwhile so I adapted. Recently, I have been bothered with my closing strategy.
My Current Buy to Close Naked Put Strategy
When I first started (and up until this post) the current strategy is to take a 50% gain on the premium collected. The easiest way to understand the strategy is with an example.
- Stock ABC is trading at $50;
- I Sell to Open 1 options contract with an expiration date in 30 days for a premium of .30 if the stock hits $40 on the date of expiration
- I Buy to Close 1 contract when the premium hits .15
In the above example I would profit $15.00, which I know isn’t a lot of money but given that is just one contract. After running through 20+ completed trades in the past 30 or so days I have started to wonder, why am I so quick to close? In the above example I have left $15 on the table – what if the option was 4 days from the expiration with no earnings coming out? Why leave it on the table when it is unlikely a stable stock is going to move 20% in 4 days?
I think there may be a better way.
My New Strategy when Exiting Naked Put Positions
My problem is that I am leaving money on the table when there is little to no chance of the naked put being assigned. I am going to attempt to create a sliding scale of whether the risk is worth taking based on the cushion between the stock and the strike price with the time remaining on the contract.
The scale outlined below are meant to be fluid. If there is an earnings call or dividend ex-date then that has to be taken into account.
When there is 30 or more days Left in the Contract
When there are 30+ days just too much can happen to both the underlying company and the larger, macro picture.
- If there are 30 or more days left until expiration if I can get 50%…take it.
When there are Between 14 and 30 Days Left in the Contract
Time decay is starting to erode the contract and there is less likelihood of something happen, so depending on the cushion I have between the current price and the strike price.
- If the cushion is 20%+ then I am going with an 85% profit required to buy to close
- If the cushion is 10%+ then I am going with a 75% profit required to get out of the contract
- If the cushion is under 10% then if I can get 50% with this time frame it is time to take it
When there are Between 7 and 14 Days Left in the Contract
- If the cushion is 20% with this little time left then I need a 95% profit required to buy to close
- if the cushion is 10% then I am going with an 80% profit required to get out of the contract
- If the cushion is 5 to 10% and I can get a 50% profit then I’ll take it
- If the cushion is under 5% then it is time to start thing about whether to roll out of the trade or take the stock and look into covered calls.
Less than 7 Days Left in the Contract
With less than a week to go it is unlikely the equities I am working with are going to move a tremendous amount, so why sell out for only half?
- 10%+ Cushion – let it expire
- 5 to 10% Cushion – 80%
- Less than 5% – 75%
This is a work in progress so I am excited to hear about any ideas/tweaks anyone may have.