As the Nasdaq has fallen by approximately 5% in the last several weeks, and many stocks have fallen by much more, I’ve received many emails about how to play these stocks. For example, “Jacob, how would you recommend getting long XYZ at these depressed levels?”
My typical response is to recommend buying a Call or Bull Call Spread, with a couple of months until its expiration, just slightly out-of-the-money. This strategy buys some time for the recent storm to pass.
Another way to play a bounce, while at the same time selling insurance and collecting a premium, is to sell puts. As I’ve written about in the past, selling puts has the same risk/reward profile as executing a buy-write, which is a more common trade for beginner-to-intermediate options traders.
For example, my scanner has picked up on the following put sales into the technology weakness over the last couple of days:
Seller of 3,000 FireEye (FEYE) December 14 Puts for $1.37 – Stock at 14.7
If FEYE stays above 14 on December expiration, this trader will collect a premium of $411,000. The math behind this is 3,000 x 137 = 411,000.
However, when you sell insurance/puts, there’s the risk that the trader will have to buy 300,000 shares if the stock drops below 14 on December expiration. That said, his breakeven on the position is at 12.63. The math behind this is strike price (14) minus premium collected (1.37) equals 12.63.
Seller of 5,000 Broadcom (AVGO) August 220 Puts for $2.60 – Stock at 239
As long as AVGO stays above 220 on August expiration, this trader will collect a premium of $1,300,000. The math behind this is 5,000 x 260 = 1,300,000.
However, there’s the risk that the trader will have to buy 500,000 shares should the stock drop below 220 on August expiration. That said, his breakeven on the position is at 217.4. The math behind this is strike price (220) minus premium collected (2.60) equals 217.4.
Lastly, here is a trade made at noon today. Try to figure out the potential gains, how much stock the trader is at risk to buy at what stock level, and his breakeven:
Seller of 2,500 Adobe (ADBE) October 120 Puts for $1.35
Feel free to send me your “homework” after you have completed it this weekend if you’d like me to check it.
I do not recommend going out and selling puts in Tesla (TSLA), Nvidia (NVDA) and every other growth stock that has fallen on hard times. That’s a potential recipe for disaster if the Nasdaq continues to fall apart, and especially with the VIX at 11.50, and the insurance premiums aren’t even that high.
However, for example, if you are willing to buy TSLA at 260 (which is currently trading at 315, and has fallen recently from 387) selling the August 260 Puts for $4 is one way a trader might execute a put selling strategy. Though I highly recommend you understand the risks/rewards in put selling before executing such a strategy.
Here is a bit more on the strategy, and a graph of a fictional trade:
Put-Writing or Selling Naked Puts
A Put-Write strategy, also called “naked puts,” is used when a rise in the price of the underlying asset is expected or a significant decline is not expected.
This strategy is often used by traders who are willing to enter a long stock position in a stock at a lower price than the stock is currently trading at.
This strategy is the sale of a put at a specific strike price with the potential for loss until the stock hits zero. The maximum profit on the trade is the amount of premium received. Think of it as writing insurance against a big fall in the stock or index. Every month you collect a small premium.
If I were to sell a put, and the stock went below my put’s strike price, I would be assigned 100 shares per put I’ve sold, thus making me long 100 shares per put sold.
For example, if stock XYZ is trading at 110 and I’m willing to buy the stock at 100, I could sell the XYZ 100 strike put for $1.
If the stock were to close above 100 at expiration, I would collect a maximum profit of $1 per put sold, or $100 per contract.
If the stock were to close at 99 at expiration, I would break even and be long the stock.
If the stock were to go below 99, I would lose $100 per contract sold per point below 99.
As I said, this is a great strategy to collect yield in a stock that you would be willing to buy.