Why I Sell Put Options (Part II)

As promised in my previous post, Why I Sell Put Options (Part I), in which I shared why I never set these types of orders and my reasoning, here is Part II. In this post I will show you the benefit of writing naked put options on 40 popular leveraged ETFs. To understand this post you'll need somewhat of a background in stock options. To learn more about options and, how options can help protect your portfolio, and allow you to speculate with less money up front click here.

If you're finding this post for the first time and don't know the benefits of selling put options compared to setting market and limit orders, you may find it valuable to read Part I. If you're following up Part I, you'll notice writing naked puts on these leveraged ETF's bring much greater premiums.

All data as of market close Monday July 20, 2009.

HOW TO READ THE TABLE

NOTE: When using this strategy, I first decide what I am willing to pay for the ETF. Let's keep it simple and say I'm willing to buy the ETF at a price of 5% lower.

Abbreviations used in table:

• Price: The most recent closing price (last quote price) for the ETF
• 5%: The price which I am willing to pay for the ETF which is 5% lower than the closing price
• Strike: The closest contract strike price to the 5% lower price. It may be slightly higher or slightly lower than the 5% lower price.
• Prem.: This is the theoretical premium received from selling the put option
• Adj. Cost: This is the adjusted cost for the ETF, if you do happen to end up with the shares at expiration.

The first ETF listed in the table below is the Direxion Daily Financial Bear 3X (FAZ). An example of this option strategy on the FAZ would be interpreted as:

Sell the Direxion Financial Bear (FAZ) August 39 put option. This will give you $3 a share or $300 per contract. If FAZ expires above the indicated strike price, you profit 100% of the premium received, if not your cost per share of the stock is $36, 12.2% lower than the close price and 7.7% lower than the price I was willing to pay with a limit order.

ETF	Ticker	Price	5%	Strike	Prem.	Adj. Cost
Direxion Daily Finan. Bear 3X Shs(ETF)	FAZ	41.01	38.96	39	3	36
Direxion Daily Finan. Bull 3X Shs(ETF)	FAS	49	46.55	46	3.4	42.6
Direxion Daily Energy Bull 3X Shs(ETF)	ERX	30.7	29.17	29	2.05	26.95
Direxion Daily Energy Bear 3X Shs(ETF)	ERY	20.34	19.32	19	1.3	17.7
ProShares UltraShort Basic Materls (ETF)	SMN	16.97	16.12	16	1.05	14.95
Direxion Daily Small Cp Bull 3X Shs(ETF)	TNA	30.26	28.75	28	1.75	26.25
ProShares UltraShort DJ-UBS Crude Oi ETF	SCO	19.41	18.44	18	1.08	16.92
ProShares Ultra DJ-UBS Crude Oil(ETF)	UCO	11.05	10.50	10	0.6	9.4
ProShares Ultra Financials (ETF)	UYG	4.09	3.89	4	0.22	3.78
ProShares UltraShort Real Estate (ETF)	SRS	18.07	17.17	17	0.95	16.05
Direxion Daily Large Cp Bull 3X Shs(ETF)	BGU	37.1	35.25	35	1.95	33.05
Direxion Daily Tech Bull 3x Shs (ETF)	TYH	107.38	102.01	100	5.25	94.75
ProShares Ultra Industrials (ETF)	UXI	21.05	20.00	20	0.93	19.07
Direxion Daily Large Cp Bear 3X Shs(ETF)	BGZ	31.24	29.68	29	1.38	27.62
ProShares Ultra Oil & Gas (ETF)	DIG	27.34	25.97	26	1.1	24.9
ProShares UltraShort Oil & Gas (ETF)	DUG	17.87	16.98	17	0.7	16.3
Direxion Daily Small Cp Bear 3X Shs(ETF)	TZA	19.78	18.79	17.5	0.77	16.73
ProShares Ultra Technology (ETF)	ROM	36.3	34.49	35	1.38	33.62
ProShares UltraShort Financials (ETF)	SKF	38.73	36.79	36	1.45	34.55
DIREXION DAILY 30Y T	TMF	37.57	35.69	35	1.4	33.6
ProShares UltraShort Semiconductors(ETF)	SSG	27.47	26.10	25	1.02	23.98
ProShares Ultra Semiconductors (ETF)	USD	24.85	23.61	22.5	0.9	21.6
ProShares UltraShort Russell2000 (ETF)	TWM	39.29	37.33	37	1.42	35.58
ProShares Ultra Russell2000 (ETF)	UWM	20.41	19.39	19	0.73	18.27
ProShares Ultra Basic Materials (ETF)	UYM	19.81	18.82	17.5	0.68	16.82
ProShares Ultra QQQ (ETF)	QLD	41.26	39.20	39	1.3	37.7
ProShares Ultra S&P500 (ETF)	SSO	27.77	26.38	26	0.8	25.2
DIREXION DAILY 30Y B	TMV	82.9	78.76	75	2.3	72.7
Direxion Daily Dpd Mkts Bear 3x Shs(ETF)	DPK	27.71	26.32	25	0.75	24.25
ProShares Ultra Dow30 (ETF)	DDM	31.31	29.74	29	0.7	28.3
Direxion Daily Tech Bear 3x Shs(ETF)	TYP	17.19	16.33	15	0.38	14.62
ProShares Ultra Real Estate (ETF)	URE	3.69	3.51	3	0.08	2.92
ProShares Ultra Gold (ETF)	UGL	34.8	33.06	33	0.75	32.25
ProShares UltraShort S&P500 (ETF)	SDS	51.24	48.68	48	1.1	46.9
ProShares UltraShort Dow30 (ETF)	DXD	43.41	41.24	41	0.93	40.07
ProShares UltraShort QQQ (ETF)	QID	29.15	27.69	27	0.6	26.4
ProShares UltraShort Industrials (ETF)	SIJ	39.4	37.43	35	0.77	34.23
DIREXION DAILY 10-YE	TYD	48.38	45.96	45	0.85	44.15
DIREXION 10Y BEAR	TYO	70.64	67.11	65	0.82	64.18
ProShares UltraShort Gold (ETF)	GLL	14.5	13.78	13	0.13	12.87

All of these options expire on August 22; therefore the last trading day is Friday, August 21, 2009.

These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

I've been using this strategy to purchase my shares and I find it has been working well. It's a bad idea to use this strategy as a form of speculation, in other words selling a put for the premium just because you think a stock will never get to a lower strike by options expiration. Remember even if the stock goes to $0 a share, you're still obligated to buy it for the indicated strike. To learn more about selling puts and other option strategies check out my option trading books.

Disclosure: Long BGZ, FAS, FAZ, TNA, UCO, URE

Comments

[Mad Hedge F...:]

Notice there are no old put sellers, but it might work short term. “Please ignore everything I told you a week ago” was the sorry message I received from multiple technical analysts over the weekend, as they updated their weekly charts. Last week they told you it was going down, and now they are telling you they don’t know. Unfortunately, these days markets are so interlinked that if you get one wrong, you get them all wrong. So the short squeeze in the S&P 500 (SPX) last week triggered a big sell off in the dollar and Treasury bonds (TBT), and healthy rallies in emerging markets (EEM), commodities (DBA), crude (USO) and other reflation instruments. This kind of bipolar, manic-depressive type of trading may be a feature of capital markets for years, if not decades to come. Technical analysts and day traders rule when nobody else cares and volumes are low. I watched the Nikkei trade a 14,000-21,000 range for ten years, with dozens of furious short covering rallies followed dependably by slow bleeds, until it finally broke down to the high 6,000s, off 85% from the top. Keep those stop loss orders permanently in place, and fasten your seat belts, or stay away.

Jul 21 09:51 AM

[msburko:]

How do you reconcile the situation of having to buy a stock for more that the market price?

For example: Assume FAZ drops to 33 and your are assigned your put. You have to buy the $33 dollar stock for $36.

I expect that would bother me for weeks if it happened to me.

Jul 21 01:36 PM

[Carneades:]

If you never use market orders, and only rarely use limit orders, then what sort of an order do you use to sell the put option?

Jul 21 04:54 PM

[Marco Hickey:]

Limit stock orders.. You know what I mean. I use limit option orders to place my put option trades.


On Jul 21 04:54 PM Carneades wrote:

> If you never use market orders, and only rarely use limit orders,
> then what sort of an order do you use to sell the put option?

Jul 21 05:07 PM

[Anthony B:]

I got to agree that selling puts is a good way to get paid to get in at a good valuation. You call always roll them up too to get more gains from an upside move. I've been doing this very successfully with AAPL for the last few months.

Jul 21 05:59 PM

[Mark123:]

I have been doing the same thing for 10+ years.... a few loosers, but overall gainers.... Quit my job almost 11 years ago to do this exact strategy.....

Jul 22 12:20 PM

[untrusting ...:]

Would agree selling puts, collecting premiums, and only buying at lower forced price you would be willing to buy at anyway ,,,, is a very good strategy. Only problem is you generally have to go about 6 months out on puts to get any half decent premium if you want puts with much lower strike prices than current market price. Also, it helps to have a falling market when you sell the puts as the premiums should be increasing then. Also think that selling covered calls on any long positons you hold, at much over your cost price, is also a great way to go. No problem getting called out with guaranteed profits of 30-50%+. Puts and calls have significantly improved our investment returns and we rarely have been exercised on any of them. Basically options have returned way more than dividends we have collected.

Jul 26 11:44 PM

[RogerG:]

ETF Ticker Price 5% Strike Prem. Adj. Cost

Direxion Daily Finan. Bear 3X Shs(ETF) FAZ 41.01 38.96 39 3 36
Direxion Daily Finan. Bull 3X Shs(ETF) FAS 49 46.55 46 3.4 42.6

How can you reconcile the idea of going long both FAZ and FAS at the same time?

Aug 09 07:27 AM

[nvs99:]

I too have been using this strategy for many months now. While I have generated good income from this strategy, I have also lost out on many good opportunities. For example, I sold puts on BIDU when it was at 110, AAPL when it was at 70, GOOG when it was at 280. I pocketed my premium, but missed out big time on the upside. Had I bought these stocks instead of selling puts, I would have made a lot more money. Lesson learned: don't use the strategy when you believe the stock has a very high upside potential. Use it only if you believe it has a limited upside potential.

Aug 22 05:19 PM