As explained in Part 1 of this article on Put Selling with Deep In The Money Puts, put selling has many different strategies that can be applied to different markets whether they be bear or bull. Put selling with deep in the money puts works very well in bull markets on rising stocks.
In Part 2 we will look at the present Coca Cola Stock put selling trade I started on Feb 10 2012 through selling deep in the money puts for January 2013.
Put Selling Recap
On Feb 10 2012, Coca Cola Stock fell to $67.42 and then closed at $67.94. Based on past dips in Coca Cola Stock over the preceding few weeks it seemed obvious to me that the stock was being accumulated and was probably going to be pushed higher.
Why Choose The Deep In The Money Puts Strategy
While a call option would certainly have been a good strategy to use, all options are wasting assets and if I was wrong and the stock did not rise but stayed sideways, the value of my call option would be eroded. Instead I prefer to stay with put selling and picking adequate strike points to sell.
Since I believed that Coca Cola Stock was going to be pushed higher, and at the same time I wanted to secure for my trade some protection, I looked at the Coca Cola Stock chart and realized that anywhere around $65.00 based on 2011 stock movement, would be a good entry point should I be assigned shares.
Deciding What Deep In The Money Put Strike To Sell
I could have sold the March $65 put and left it as a naked put trade but then I would have earned .62 cents or less than 1% for the put selling trade versus earning who knew what should the stock rise.
Why January 2013?
I looked at the deep in the money puts that were available and went out to January 2013 which would allow my trade plenty of time to either work in my favor through a rise in Coca Cola Stock, or allow lots of time for adjustments should the trade not work out and Coca Cola Stock either fall in value or trend sideways.
Further Out Buys Me More Time AND More Premium
As well, by going further out in time I was earning a very large put option premium which reduced my break-even in the stock.The whole purpose of selling deep in the money puts was to earn profit as the stock rose but also being aware of the possibility that this trade could end up badly. Therefore time and a larger earned put premium are on my side by going out to January 2013.
Why Put Selling The $77.50 Strike?
When I looked at the deep in the money put premiums for January 2013, the $75 put actually had decent premium and would have placed my break-even around $64.80 which would have been a great price, but I felt that the likelihood of Coca Cola moving to $75.00 was reasonable. From $67.90 where Coca Cola Stock was on Feb 10 2012 to $75.00 represented a gain of 10.4% which I believed the stock could easily muster.
The $80.00 strike was also compelling since that would represent a return of 17.82% which might be on the high-side. I therefore determined that I wanted to aim for a gain of roughly 15%. My annual goal is always around 12% so if I aimed for 15% and this put selling trade returned just 12% I would be quite happy.
The $77.50 January Coca Cola Put could be sold for around $12.35 on Feb 10 2012. $77.50 would return 14%. When I added in the put premium I could earn through put selling the $77.50 January put strike for $12.50 the actual return if the trade expired with Coca Cola Stock above $77.50 would be 18%. The return of 18% would be like selling the stock for $80.00 without the stock having to rise that high.
The $12.35 put premium would also mean that my break-even in the stock would be $65.17 after commissions. When I looked at the Coca Cola Stock chart for 2011, $65.00 was a great spot to should I be assigned shares.
Put Selling With Deep In The Money Puts Means Assignment Can Happen At Any Time
When put selling with deep in the money puts it is important to remember that you are now deep in the money and assignment can happen at any time. While it is highly unlikely to have the stock assigned when holding puts so far out in time, January 2013, it can happen and investors need to be aware of that fact and prepare accordingly.
Deep In The Money Puts Sold Feb 10 2012
On Feb 10 2012 then I started put selling with Deep In The Money puts and sold 10 January 2013 $77.50 put options on Coca Cola Stock. The premium received was $12.35. This effectively placed my break-even in the trade at $65.17.
If the stock fell below $65.17 between Feb 10 and Jan 18 2013 (Jan 2013 Options Expiry) I would lose money. If the stock was above $65.17 I would make money.
Deep In The Money Puts Coca Cola Stock Break-Even Calculation
10 Puts Sold at $77.50 = $12330.50 after commissions. Capital required = $77.50 X 1000 = $77500.00 – $12330.50 = $65169.50 / 1000 shares = $65.17 per share cost.
Put Selling With Deep In The Money Puts Advantages
There are many different types of put selling strategies that can be employed against a rising stock to earn profit and income while the stock is rising. My Microsoft Stock Put Selling Trade is one such example. In the Microsoft Stock trade I engaged in traditional put selling at increasingly higher strikes as the stock rose.
I then turned to the early warning tools to spot a collapsing stock to watch the rally in Microsoft Stock to try to spot when it is about to end to close my sold puts early and avoid or minimize any loss.
However the put selling strategy of selling deep in the money puts has other advantages which traditional put selling does not.
When I sold the Jan 2013 $77.50 puts my intention was to capture as much of the push higher of Coca Cola Stock as possible. At the same time I can close at any time which means if the stock rises to perhaps $75.00 by spring or summer 2012, I can close my puts lock in my profit and move my capital to another trade.
Put Selling With Deep In The Money Chart Summary
The Coca Cola Chart below illustrates my trade. I sold the $77.50 puts for Jan 2013. I will profit from this trade as long as the stock stays above my break-even of $65.17. If Coca Cola Stock falls below $65.17 I will lose on the trade. Meanwhile I can buy to close my put trade anywhere above $65.17 and reap a profit. The higher Coca Cola stock moves by January 2013 the more profit I will earn, however I can buy to close my deep in the money puts at any time and end the trade either for a profit if above $65.17 or a loss if below $65.17.
Put Selling Deep In The Money Puts Advantages:
1) No matter how low Coca Cola Stock (KO Stock) should fall, I know my share valuation in advance. It is $65.17.
2) I have been paid my profit up front. When I sold the deep in the money puts I was paid $12.33 per share of Coca Cola Stock after commission.
3) The amount of put premium paid is large enough to assist with other trades. For example with the money earned, namely $12330.50, I could buy call options on Coca Cola Stock or I could sell 5 puts against Intel Stock at March $26 or April $26. I can use the capital for whatever other trade I wish. Basically I am “borrowing” my profit in advance and using it now. Should the trade not work in my favor or not make the kind of return I was hoping for I can close both these deep in the money puts and the secondary trade I put in place with the “borrowed” profit and end the put selling Coca Cola Trade.
4) One distinct advantage is when Coca Cola Stock climbs. If the stock climbs I can turn this naked put trade into a credit spread by purchasing Coca Cola Puts for protection. For example today (March 30 2012) with the continued rise in Coca Cola Stock (KO Stock) I can buy August 2012 $65 puts for $.47 cents which means any loss in my trade between now and August would be .47 cents + .17 cents = .64 cents. Therefore my total loss of this Coca Cola Stock put selling trade does NOT work out, is capped at .64 cents X 1000 shares = $640.00.
If Coca Cola continues to climb I can sell the August 2012 $65 puts and buy puts higher up, perhaps $70.00 or eventually $75.00. This acts as a stop-loss mechanism the same as it would on a stock purchase. Each move higher in my protective puts locks in profits and ends losses. If Coca Cola Stock moves high enough, perhaps $77.00 or higher, I should be able through buying protective puts turn this trade into a profitable trade no matter what the outcome.
5) By put selling the January 2013 deep in the money puts I have between Feb 2012 to January 2013 for Coca Cola Stock to rise and generate a profit.
6) By put selling the January 2013 deep in the money puts I have stayed with a wasting asset which IF the stock CLIMBS works in my favor as each day the value of my deep in the money puts will erode a little.
7) I have almost 11 months to make changes and adjustments to this put selling trade including rolling it out further in time and if the stock should rise, buying puts at increasingly higher strikes. In other words I have 11 months to apply a variety of strategies to this ongoing trade.
8) I can close at any time if I feel there has been enough profit made or I believe the rally in Coca Cola Stock is ending.
9) I can capture the profit in this trade right up to and including $77.50 which if the stock should reach $77.50 amounts to about 18% profit.
Put Selling With Deep In The Money Puts Conclusion
You can see then that there are some distinct advantages to put selling deep in the money puts. There are of course disadvantages including possibly having the stock assigned early, which if Coca Cola Stock does not rise could happen. However I would be happy to own the shares at $65.17 which is why presently I do not hold any protective puts. At $65.17 I should be able to sell covered calls easily to be exercised from the stock at some point.
This then brings up perhaps the most important aspect of put selling with deep in the money puts. Stock selection is paramount to success. I only ever use this strategy on stocks I would own in any event and for any length of time. They must be a large cap dividend paying stock with reasonable option value since if I end up holding the stock I want to be able to sell covered calls.
Like any put selling strategy, deep in the money puts have their place in any investors tool box of profit and income strategies.
Review Put Selling With Deep In The Money Puts Part 1