Currently the SPY trades at 131.20. December 17th $80 puts carry a premium of $.58/share ...that is $58/contract. Given you have the cash and/or equity to back up any unrealized losses which may occur, as long as the SPY stays above $80 you will collect a premium of $58/contract:
That isn't bad given that the general probability of the SPY losing about 64% of its value by year end is very low. To put this in better perspective: when the devastating earthquake and tsunami rocked Japan recently, the Nikkei dropped about 17%, something so powerful and unlikely still did not take the markets down even close to 64%:
An interesting utilization of this strategy is to almost always outperform a particular index. If for instance you are a money manager and are benchmarked against the SPY, you can basically invest in the SPY to match the returns exactly. But you can then write as many deep out of the money puts as you would like, collect the premium, and so long as you do not see a black swan (not the wonderful movie), you outperformed the benchmark with the extra proceeds you collected from writing the puts.
The strategy is interesting because it is relatively safe and easily executed, however the downside risk is simply incredible. You could consistently profit from this strategy numerous times, but the one single time you're hit...be it even once out of 100, you could lose more than everything you've ever made.
Loss on 1 contract if SPY goes to $75: $80-$75 x 100 shares= -$500 + $58 premium = -$442
The real crutch of this strategy is whether you can back up say a 60% unrealized loss with your broker. If you do not have the cash or equity to back up your position after the market turns against you, the brokerage could very well liquidate your position. But if you have the money and a good understanding of market valuation, this could definitely be a great income generating strategy.
I like this approach, assuming that the puts are sold on equities that would be considered a bargain at the strikes selected and that you have the means to pay for the assignment. Even in the event of a black swan event, the likelihood of the index or even some stocks (e.g. AAPL, IBM, GE, Amazon, etc) going to zero is extremely small. Accordingly, you would be sitting on very solid investments at fire sale prices and likely collecting dividends in the interim. Patience and a lack of greed would be rewarded in any case.
ReplyDeleteThe owner of a common stock collects a dividend. Selling a put is only the right to transfer ownership to you. Therefore, you do not collect any dividends on options. In fact, dividends become a carrying cost on the position. Deep OTM options really shouldn't be impacted by options, however.
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