Part 1 - CASH-SECURED PUTS

Joseph R. Stadelnikas, M.D., M.B.A.

We will cover, after selecting dte and underlying

Selection of Strike Price based on

% AR (annual return)
% BE (breakeven)

Choosing Alert Price for possible exit based on

ER (expectancy ratio)

Decision to take Early Profit based on

Rolling process, if stock increases

Rolling guidelines, if stock decreases

In Part 2, Covered Calls will be covered.

1 Choose an underlying (UL) to trade your CSP.

Example only: IWM

2 I look at last 5 year history of the underlying.

If trading monthly expirations, I calculate history of monthly
movement. # months in last 60 months,
 a > -3%, -5%, -7.5%, -10% and > -15% decline.

3 Choose a date of expiration (dte)

4 Choose % Annual Return (% AR) you require to have your capital

at risk

5 Choose % Breakeven (% BE) you require for protection of your

capital at risk for that % AR

Example only: dte ~ 28, % AR > 8%, % BE > 8%

Run a quick scan or just read the option chain for particular dte.
Eliminate all strikes that don’t meet both required metrics. That usually
leaves 3 to 8, or more, to choose from, some with higher % AR, but
meets your % BE and some meets your % AR, but higher % BE.

You are the decider, look at where market is, there a need for higher
protection or less? You need higher return? Let’s see what a scan
reveals.

SCAN
Poweropt calculates % AR on mid-price ($1.90), not the bid of $1.86, so % AR is
13.8% not 14.1%.

You can see the scan had 13 strike choices that meet both metrics,
criteria of % AR and % BE, > 8% for each.
Range of % AR is low of 9.7% to high of 25.7%
Range of % BE is low of 8.2% to high of 15.1%.

So, you as the owner choose and taker ownership of your strike choice.
We all set our own % for both AR and BE.

For this paper, I will choose mine as well.

Why, my choice? $176 strike. IWM high has been $244.46. Current
price is $198.66. Strike chosen is $176 for $1.86 premium and
breakeven of $174.14. Meaning I begin to lose money if stock drops
28.8%, well below a Bear market definition. That is a 14.1% AR with
12.4% BE from current price of $198.66.
Fits within my risk profile.

Now we are not finished? All CSP’s start with identifying the max
profit and the % probability of max profit and with the % probability of
max loss and we know,

Max profit is $1.86, % probability of max profit is calculated as 90%

(probability above strike), % probability of max loss is (100-90) or 10%.
Is it important to identify what max loss we will tolerate? For me,
absolutely, I have no clue why so many traders feel it is unnecessary at
time of the trade. We are all different. If you don’t know, exactly how
can you determine your strategy is a successful one?

Probability Calculator

P > Strike = Probability Above Strike at Expiration

If you don’t decide on a max loss you will tolerate at the beginning of
the trade, ask yourself, when sh*t is hitting the fan, do you think and act
rationally?? You are forgetting that all trades has an exit at the
beginning, whether we choose it or Ms Market does. Ms Market will
decide, if we don’t. I am not sure most will be happy with her choice.
Am I saying I set a stop-loss trade in the beginning?? NO. I am saying I
have a price set, I calculate for each trade I place before trade is
executed, I set an alert, and, if triggered, that requires me to evaluate
overall status of all open trades and current trade. This does not mean I
will just close.

Now, how do I set my alert? I calculate an exit with an ER I require.

I hear the question, what is ER? It is expectancy ratio, it is the major

determinate of whether your strategy is one that is successful or a
failure. It is NOT that POP (probability of profit) most believe is the
major determinate of success.
Again, your choice to use what you like. I use a minimum ER of 1.5 and
up. The higher above 1 is good, breakeven = 1, the higher, the easier you
will generally find it is to adjust and less management necessary.

Too many traders seem to always be concerned about POP (probability

of profit), when that is only just one factor that is determinant of profit
or loss, success or failure. Below is what determines if one has a
successful strategy and plan.

Expectancy Equation
The example, we chose 28 dte, $176 put. I usually set an ER of 1.5 to
2.0.

I will see what exit would = ER ~ 2.0 and 5.0

ER 2 is exit 8.9% decline ER 5 is exit 10.6% decline

You can see, there is NO right or wrong answers. Lots of choices have
to be made trading CSP’s or any strategy. A FB group cannot make
your choices for you. Your decisions, your trade, take ownership of
success and failure.

Remember, a single trade is just one small brick that is part of the
construction of your House of Success. Do not be overwhelmed by a
few defective (failed) bricks when constructing your house, even a
contractor knows he has to factor in wastage (extra cost) when ordering
his bricks for his construction. It is just a cost of building successfully.
Remember, the choice of underlying, dte, strike, exit is yours and yours
only, not anyone else. This is just a process I use to set-up my initial
CSP trade and should be read in that light ONLY!

When does one close a CSP to realize early profit?

Again, there is no right answer, this is a process that can be used, modify
it for your goals.

Now that we have our initial CSP decided and executed, what does one
do if stock increases and the trade is showing a good unrealized profit?
When do you close to realize the profit showing and when do you
continue? This question is one I often hear asked.

If I plan to take early profit I have 2 criteria I use.

One, if I see an unrealized profit of 20%-30% of initial premium

And

Two, if profit / days in trade ≥ max profit / days to expiration

Criteria
20%-30% π realized and π/dit ≥ max π/dte

If both criteria met, I re-evaluate the impact of taking early profit in this
trade would have on entire portfolio.

Date of trade was 3/4/22, stock was $198.66. On 3/10 you see stock at
$200, current profit at $65, a 35% realized profit.
 Both criteria met,
35% profit realized if closed and $10.83 ≥ $6.64

When a CSP is open we know the % AR. In this example it is 14.1%.

(some calculations I will show is 13.8% AR). The difference is I use the
bid price to calculate the % AR, poweropt uses the mid-price of $1.90.
Won’t make any difference for this discussion. So for rest of discussion
I will use my calcs, the bid price for the CSP. 13.8% AR. When we are
looking to decide to take early profit it is helpful to calculate the % AR
if you exit and the % AR that is remaining, ie. left on the table and gone.
Many believe (1-2) is equal to (1-3) plus (3-4). Let’s see if that is a
valid assumption.

1.86/176 * 365/28 = 13.8%

0.65/176 * 365/ 6 = 22.5%
1.21/176 * 365/22 = 11.4%

If we realize the early profit, we would have a 22.5% AR on capital

when initial trade the % AR was 13.8% at expiration, if it expires.
Before anyone tells me about the Kool Aid some clowns serve, so don’t
bother telling me about studies, none, no studies have been done.
Sounds like a good decision. Higher % AR of realized profit if closed
and with taking off 22 days of risk or using capital to do another trade
and add more possible realized profit. This is where one has to
understand they are making a major assumption and you have to be
comfortable with it. You are leaving 11.5% AR on the table by closing
early and assuming your next trade, you use with your capital freed up,
will have a higher realized % AR than 11.5%.

If my plan is to just take early profit and if it now meets my criteria and I
am ok, I just realize the profit and move on. However, if plan is to roll,
as many do, before I close, I want to see how that trade affects my
decision.

Before anyone says, all this is so complicated and time-consuming, it is

not. If it was I couldn’t do it. Simple spreadsheet, plug in a few
numbers and all is calculated for you. Only thing we have to do is wake
our brain up and have him think for once. (not just follow others).

Let’s look at a possible roll.

What dte? I look at number of days in the trade (dit) when closed and
add that number to original dte to look for a new expiration date. So if
closed there was 6 dit so 4/8/22 expiration is acceptable.

One can BTC $176 for ($1.21), STO $177 for $2.04. Rolling up $1 to
$177, gives additional premium. BTC @ ($1.21) realizes $0.65 profit
and the $2.04 for strike of $177 opens a new CSP.
If plan was to roll, we now have all the information necessary for a
decision

Initial % AR was 13.8%,

If you take early profit of $65 (35% of premium)
Closing is a 22.5% AR
That would leave 11.4% AR on the table, unrealized, gone
The new position is 14.5% AR at expiration

All in all, decision to take the early profit and realize it with the new
position is a good decision, imo. Trader needs to decide.