A poor man’s covered put is a bearish strategy that is the opposite of that The poor man’s secret phone call.
We buy a long-term in-the-money put and sell a short-term out-of-the-money put against it.
If you were just starting out with options, your brokerage firm probably started you with this covered call Strategy.
It is easy to learn and only offers long stock and short call options.
When you’ve got some experience, take this one The poor man’s secret phone call and replace the portfolio in the covered call with a long-term ITM long call option.
Then you heard about that put under a roof Wait, what about short stock and short put options?
In all honesty, when I started options trading, I was really confused by this strategy.
I encourage you to read through the put strategy that is covered to make sure you really understand the mechanics.
Now, with the poor man’s covered put, we’re going to replace the short stock with long-term ITM long put options.
We’ll move quickly through the following points and then with a few examples everything should become clear.
Let’s look at a quick example:
Date: February 22, 2021
Current price: $ 126.64
Buy 1 AAPL Jan 21, 2022, 160 Put @ $ 40.55
Sell 1 AAPL March 19, 120 Put @ 2.04
Bonus: $ 3,851 net charge.
Breakeven price: About $ 129
Maximum loss: $ 3,851
The covered put uses 100 short stocks and a short OTM put option.
The maximum loss for the covered put is undefined, since the share price can theoretically rise indefinitely.
The poor man’s covered put (PMCP), on the other hand, consists of a long ITM put option and a short OTM put option.
Together these options result in a diagonal spread. In particular, a PMCP is also referred to as a long put diagonal spread.
As with most long spreads, our maximum loss is equal to the charge paid to open the spread.
In the case of our AAPL example above, both the premium paid and the maximum loss are the same at $ 3,851.
As mentioned above, the PMCP is a long diagonal spread.
Diagonal spreads are really a combination of vertical spreads (different strikes with the same sequence) and Calendar spreads (The same strikes with a different sequence).
Since we have different expiration dates, we cannot know for sure the maximum profit or breakeven price for the spread as we may not know it implied volatility of options for the first expiration period.
This is really not a problem as we can only base our target exit price on a profit of 20 to 30% on the direct debit paid.
Risk of assignment is usually only an issue when the stock price falls below your short put strike and the expiration date is nearing.
Honestly, by the time this situation develops, we should have closed the position to make a good profit.
If Assignment When that happens, just close the assigned shares and the long put if that is part of your schedule.
We’ll be discussing different time horizon strategies soon.
The PMCP does not suffer from this dividend Payment risk unless you are assigned short stocks prior to the ex-dividend day and the stock pays a dividend.
This is a big risk with covered puts as they are designed to use short stocks.
Gamma Risk is always available as options near the drain.
This leads to large fluctuations in option prices that we can do without.
It is a good idea to close the short put at least a week before it expires.
Overpayment risk is a risk that can be avoided by never paying more than the spread of a PMCP.
Think about it for a moment. If you pay $ 10.02 for a $ 10 spread and both ITMs run, how much will the spread sell when it expires?
Yes, max. $ 10. That’s a guaranteed loser!
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Both the PMCP and the covered put are delta negative trades, which means that they benefit from the falling stock price.
Vegaon the other hand is not so easy.
The covered put is a short vega trade because we have short stocks and short put. We see this all the time when we Sell options with high implied volatility, buy them back when implied volatility decreases.
The PMCP is considered a long Vega trade as we have an overall debit spread.
With debit spreads, we buy them when the implied volatility is low and we want it to increase.
The fly in the ointment has to do with how far we place our long put.
One consideration is that short-term options are more affected by changes in volatility than they are long term options.
This means that our short puts are more sensitive to implied volatility and have greater price fluctuations than the puts that have been bought over the longer term.
Our AAPL example above had a Vega positive 30.
The passage of time influences the different expiration times by different amounts. Longer-term options, by definition, have a higher extrinsic value and a greater number of days to expire.
As a result, longer-term options have a lower value Theta decay Value as short term options.
Long options have negative theta decay, while short options have positive theta decay.
This means that our PMCP position has an overall positive theta decrease (we gain in value over time) as we have a long-term long put (smaller negative value) and a near-date short put ( larger positive value).
This concept assumes that all other variables such as price and volatility do not change.
Our AAPL example above had theta of plus 6, which means the position should be making about $ 6 per day by time decay.
High quality ingredients are the secret of most recipes and the PMCP is no exception.
I think the same list The criteria used for the covered call are also appropriate for the PMCP.
The PMCP is a neutral to slightly bearish strategy, so we would like to grab a stock that can trend sideways for a while or fall a little.
On 02/21/21 I found a ticker that works for a PMCP, Coca Cola (KO). RSI, CCI and Stochastic Oscillator all showed values in the middle range.
The IV percentile is 20% and there is no income on the radar. The current share price is $ 50.11 and the 52-week high is just under $ 55. This gave me my goal for the long put.
The next step is to find out the expiration times and exercise prices. Personally, I like to stick to monthly expiry times for liquidity.
I looked at the April and May expiration cycles and both had fewer than 500 open positions.
June had 550 positions open for the $ 55 strike. Perfect! That’s one side.
Now I want a tight expiry with at least 25 days to expire (DTE) for my short put.
The March expiration is 26 DTE.
There are 2 strikes with a minimum of 500 open positions, $ 50 and $ 47.5. I think $ 50 is a little too close to the current price of $ 50.11, which is $ 47.5.
Structure of the PMCP spread:
What if the closer expiration times were good in the long run?
I would still choose the June expiration, as after the March contract expires I can sell another short put OTM that expires in April and then get more premium again in May, and then another short put May sell in June, turning the PMCP into a vertical put spread.
Let’s analyze the trade a little. Our position delta is -53.23, theta is 0.78, and vega is 4.75.
These numbers are in line with our discussion above. Our cost to open the trade is $ 585 and the maximum profit is approximately $ 225.
The volatility at the time of purchase is 26.16%.
Now let’s examine what happens when the price changes.
- The price drops 10% to $ 45.10 – this is the best case for us. As you can see, our profit is around $ 180 without taking into account changes in volatility and timing. Let’s add a bit of both, using the date 03/05/21. As the price has fallen, we are increasing the volatility by 10%. Now we see a profit of $ 213. That’s a 36.4% ($ 213 / $ 585) gain if we close the trade.
- The price is unchanged at USD 50.11. This is fine with us. Since we have a positive theta decay, we make a small profit of $ 12.60 on 3/19/21. That’s fine because we’re closing this short put and opening a new one that expires in April. The small profit reduces our cost base from $ 585 to $ 572.40.
- Price rises 10% to $ 55.12 – This is not good for us as our contracts have depreciated, implied volatility has worked against us, and our puts are now both OTM. Let’s use the same date as the 5/3/21 price reduction scenario. As the price has increased, we are reducing the volatility by 10%. We expect a total loss of $ 403 if we close the position. We still have plenty of time for the long put so we can roll the short put to a $ 50 strike and expire in April. We are already facing maximum loss. So if we do the short put-up and -out rolling, we will only have more premium and time for our trading to get back into our profit zone. Be careful if you get too close to the long put strike as you could severely limit your profit potential.
The poor man’s covered put is a bearish option strategy that involves buying a long-term put in the money and selling a short-term put against it.
Delta is the main driver of trading so we want to pick a stock that we believe will decline slightly in the future.
The poor man’s covered puts are positive vega and positive theta.
The risk is limited to the premium paid.
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.