If you’re the average investor, you probably haven’t considered selling the money puts.
Ironically, you may have placed similar trades in the past.
This article explains the basics of trading.
After that, we’ll dive into the intricacies of the best times to strategically sell ITM puts in a portfolio.
Selling an in-the-money put is incredibly easy. All we do is look at the current price of the stock and find the strike at the money (shown in green).
We then keep looking up the chain on the put side.
These are the options we sell when we sell an ITM put (shown in red).
Comparing Apples to Apples (Covered Call vs ITM Put)
Many private investors have a tendency against it Sell puts.
I recently spoke to a middle-aged investor.
Let’s call him Dan.
We talked about a stock Dan liked.
I asked him openly whether he would sell an ITM based on his thesis.
Dan scoffed …
“Sell puts ?! Are you crazy! I only implement covered calls in my portfolio. I invest my account in low risk income strategies. “
After some back and forth, Dan was still confused.
To clarify, I showed him the risk profile of a covered call against an ITM put.
Before you think I missed a second graphic, I assure you I didn’t. The graphics are the same.
Buying 100 shares and selling 1 OTM call is equivalent to selling 1 ITM put
Turns out Dan was a salesman!
We defined an in-the-money put as the same thing as a covered call.
It is now important to justify the benefits and costs of selling.
Because of this, it is easiest to revert to the covered call.
With a covered call, we have 100 shares of one share.
We decide to sell an OTM call on these stocks for income.
By selling the call, we reduce our risk for the shares.
This is because if the stock is sold, we will have to accept the losses but keep the premium from the call we sell.
If the share remains unchanged, we will also benefit from collecting the premium from the call we have sold and leaving the shares unchanged.
It is only the last option that we have sold our call + our premium as shown below if the stock is essentially rising and our profits are capped on the strike.
The main selling point for covered calls and thus for ITM puts is the reduced variance and the comparable long-term return when simply buying and holding stocks.
Our structure uses two premiums to generate long-term returns. The equity risk premiums (for buying stocks) and the variance risk premiums (for selling volatility).
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We are putting our greatest risk with an ITM delta.
What if the stock crashes?
We get a premium by limiting upside profits.
Even so, in a quick stock crash (as seen in March 2020) that premium is almost negligible.
Our delta, which can start around 70, quickly becomes 100.
At this point we just stop long synthetic shaft.
Therefore, emphasizing an ITM put or a covered call can be done in the same way as emphasizing a stock position for a downward move.
I would recommend stressing it for a 5 standard deviation move down.
It may be painful to look at, but it is much more painful when it happens and is unprepared.
Choosing between a covered call and selling an in-the-money put is like picking one apple over another.
They are equal.
Some investors prefer covered calls because they see the premium embedded in the contract (although higher) compared to the ITM’s premium.
This is visually appealing, but not an advantage.
Others like the dividend they get on the stocks.
This is also embedded so that apart from possible tax nuances, they are identical.
Here are my thoughts.
1. If the contract is liquid and you have no position, selling an ITM put is one trade versus two on a covered call, so you may pay fewer commissions and spreads.
2. If you’ve been around for a long time, it’s easier to sell stocks that sell a call against them than to sell stocks and then sell a put.
3. Possible tax differences can mutually benefit.
4th Sometimes ITM puts are more illiquid, making covered calls a better choice.
Extension of the fourth point.
ITM puts may seem more illiquid, but there is often hidden liquidity.
This is because a market maker sitting in Citadel can easily buy the ITM put and sell a covered call for an arbitrage.
When you have not just Citadel but multiple market makers competing for your free money, everyone who is there and is willing to do it for less will be served.
The result for the consumer is a fill price that is practically the same as a covered call, as long as you don’t place aggressive orders.
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For investors who want to manage their retirement portfolio while spending 10 minutes a day, selling ITM puts is a pretty good long-term strategy.
For those of you who are more advanced, this section is for you.
When you sell an ITM put, you are expressing this very view.
Long deltaShort Vega, Long Theta & Short gamma
In other words, I am optimistic about the Underlying but do not expect any significant price increase.
I think implied volatility and distortion are overpriced against my expectations.
Let’s look at Tesla as an example
One metric I like to look at is crooked.
The most important thing to see with an offset is a significant call offset (or a lower than normal offset).
This means that the OTM calls and thus the ITM puts trade with higher volatilities than normal against their at-the-money counterparts.
By selling this offset at its extremes, we are potentially making better trades and selling higher implied volatility.
This works on the basis that the offset mean is returning and is historically overpriced.
Tesla’s skew is shown below.
Selling ITM puts, when we see the extremes in call delay, as indicated in the red circles, could be a good place to start.
In terms of implied volatility, there are a lot of things we can look at to determine the best selling point.
One of my favorites is the implied volatility versus the realized volatility spread.
By focusing on the points where the implied volatility is highest relative to the realized volatility, we can bet on the convergence of the spread.
These are some examples of some metrics I personally use to determine when it is most beneficial to sell an ITM put.
Neither is foolproof.
Implied volatility to realization may be high as profits approach. In the case of Tesla, there may have been a risk of movement with the involvement of S&P.
As usual, you will find information that contradicts your opinion.
It’s important to analyze both sides and see if the trade still makes sense.
The key here is that your information supports the original view of a brief ITM put.
However, if you dig a little and come to different conclusions, the short-in-the-money stake is now not correctly expressing your view and needs to be removed.
Conversely, if the stock moves and your ITM put is now OTM, you now have a different view and exposure.
At this point, you can either scroll the position (if you want to keep the same view you originally had) or just remove the position.
Most important is yours Delta position.
Ultimately, it doesn’t matter what volatility data you are looking at when selling ITM and attracting a dog.
Unless we are moderately optimistic about the underlying asset, there is no need to place an order or continue to hold a position.
Selling in-the-money puts is often overlooked as a strategy, although it is an easy alternative to a covered call.
For regular investors, they provide a source of income and lower variance without offsetting the long-term returns.
For the advanced investor, this is another option strategy in your toolbox. One that expresses a moderately optimistic assessment of the price while taking advantage of the overpriced volatility and increase.
Disclaimer: The above information applies to For educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are unfamiliar with exchange-traded options. All readers interested in this strategy should do their own research and seek advice from a licensed financial advisor.