Friday Q&A Hello Smart Option Sellers! Before we get to the questions, let's touch on what effect the big move lower in Big Lots (BIG) today will have on our portfolio. I know some of you have concerns, and even just thoughts, on what can happen now that a stock in our portfolio has moved below the strike price. I just want everyone to know that I am here and will be with you every step of the way. I will always answer your questions, especially when things get a little stressful due to market sell-offs. Let's go over some points of interest. Point #1: Stocks can, and will, move lower than our strike price on various occasions, even though we started with a very big cushion. It doesn't happen that often for us, but every once in awhile, we have a move like BIG experienced today. What happened with BIG anyway? BIG announced earnings this morning before the opening bell, and even though some of their numbers beat analyst estimates, other numbers didn't, and it was the less-than-stellar guidance moving forward that really hurt the stock. By the end of the trading day, BIG dropped $9.30 to its current price of $31 per share. That's an extremely large one-day move for a stock like BIG, and it has now pushed below our put-sell strike price of $32.50. The put option price has moved from $.25 per contract just yesterday, to its closing price of $2.85 per contract today. At the moment, that puts us in the red on this position by roughly $2.50 per contract. Point #2: Stocks can, and will, bounce back. Typically after a very large move like what BIG experienced, it will usually have a bounce, as smart investors know that much of the selling was overdone. The adage of "sell first, ask questions later" was on full display. People wanted out, and they sold the stock hard. But as I said in today's earlier alert, the general bearish mood of the market is hurting all stocks. Coupled with a bad earnings report, we can see how BIG probably fell more than it should have. It's scary out there for some investors. The continual volatility, and the large down-moves can ramp up the stress factor. You get that doomed feeling in the pit of your stomach that everything is just going to keep falling and all companies will go out of business. That's how the psyche works when money is on the line - you have images of worst-case scenarios. But we all know that cooler heads eventually prevail, and that stocks find a bottom and move back up. The question is - are we near the bottom yet or is more selling to come? Hard to answer. Stocks have fallen a good amount and we're getting to critical support areas on the charts. I'm more of a chart guy when it comes to picking trades, and the Dow, the S&P 500, and the Nasdaq all will soon hit upon major support. Those levels are 23,500-24,000 for the Dow, 2,600 for the S&P, and 6,800 for the Nasdaq. If those levels hold, we should see a significant bounce. If they fail, we will probably see a waterfall move lower. Point #3: What do we do moving forward? One of the things I've always done with our put-sell trades is to give us a huge margin for error to the downside. This is because I'm a very conservative guy and for the last ten years, the market has gone up practically unabated. With the thought of an eventual pull-back always on my mind, I want to play it safe. I think we all knew at some point there was going to be a big sell-off. So, planning for that move is how I've structured the trades. Now, it all comes down to how much more room for error do we have, and what will we do when that cushion gets very small? This is when we can employ our defensive strategy of "rolling" the trade. Since there is the possibility that stocks can fall further, it makes sense for us to lower our potential buy-in price on the stock. If we don't feel confident about potentially buying BIG at $32.50 per share, we can roll the trade down to a lower strike price using a further-dated expiration date. Since more time to expiration leads to higher option prices, we can swap out our current position for a different one. This type of activity would have us buy back our current January 2019 BIG $32.50 put-sell position for a loss, while selling a new put-sell position for the April or July 2019 expiration date using either a $27.50 or $30 strike price. The sale of the new put option would be for a price that would completely compensate for the loss we'd take on the original position. This would lead to an opportunity to still have an overall win between the two trades. The only draw-back would be is that we'd have to stretch the trade out for an extra few months. But if that's what it takes to be profitable on the position, then that's what we'll do. My other question to you is this - do you have any concerns with building a diversified long-term portfolio of stocks? Because eventually, we may end up buying a stock. And at times, that stock may go lower. Stocks have been the best performing asset class over the last 100 years. If you're interested in building long-term wealth, you have to be invested in stocks. Look at Warren Buffett. He's arguably the most successful investor of our time. He's done it by holding stocks for long periods of time (forever, according to him). And he doesn't sweat the down-moves. We just learned that Apple has now become Buffett's largest holding to date. He's recently built upon that position, and the stock has moved lower. Think he's worried? Heck no! He knows stocks will go back up again. And that's the outlook we should have. But we have to decide whether it makes sense to roll the position or possibly take the assignment at our current strike price and buy the shares. If we end up buying the shares, we can hold for unlimited upside gains. If we roll, and are successful in that the put option expires worthless, we can only make a profit to the tune of whatever we sell the put option for. I can tell you from experience, you can make lots more money by having a stock appreciate in price versus just collecting put option premiums. I'm in no way downplaying how successful we've been at selling puts. We have lots of Smart Option Seller members who have made lots of money since our inception since January 2017. But option selling has a limited upside, capped at what you sell the option for. Being long shares of stock has no cap to the upside. I think eventually we should buy shares of stock and everyone will see how profitable that can be. And that subject leads me into our next point. Point #5: When our stocks fall (like BIG), you may see the value of your portfolio decline, and/or even receive a margin call from your broker. Since most brokers require a roughly 20% margin requirement when the put-sell is first initiated, you may notice that when the stock falls, your margin requirement to hold that specific put-sell position will go up. This is the broker's way of protecting themselves and making sure that you have the funds to pay for the stock in full in the case of assignment. An increased margin requirement will take away from available funds you may want to use for other trades. If anyone finds themselves in this predicament at the moment, you can either add more funds to your account, roll the position (even before we do it officially), or buy back some of the put option contracts if you've sold multiple positions. If you buy back some contracts, you will unfortunately incur a loss. Margin requirements are a very important topic to discuss, and it's part of the Margin Primer you can read in the Members-Only section of our website. It might be worth a re-read. The other point that I've made in the past, and one that is prominent in the free Put-Selling Basics ebook, is that you should only sell put options on stocks that you would have a genuine interest in owning if it came down to it. And, you should stay within your comfort zone as far as how many put option contracts you should sell. When we have a large stock move like BIG had, it really tests whether you can follow through on your commitment to the strategy. So, let's see what happens on Monday and we can formulate a plan. Heck, for all we know, the market might bounce and we won't have to take any action. I hope my rambling has given some of you clarity and context on the finer points of put-selling and maybe put you at ease, as well. Now, let's get to the actual questions that have come in recently. Q: Hi Lee; In July I saw an article that My Pin headed politician had gotten a bill passed in the house on options trading. Bill HR 5749. Do you know about this bill? How about a comment about this to us all. Do you thing this will effect the price we will get for our options? They have 360 day to formulate a plan. You know what happens when Congress makes plans. A: Hmm, I'm not all that familiar with this bill, and before you brought it up, I've never heard of it. As far as what I can tell by a quick read, it seems that this bill is aimed at possibly stabilizing and increasing the safety measures for banks and other institutions that take part in options trading. I don't really see anything in there that will affect us as individual traders. I'll have to look into this further, and will keep my eyes and ears open for more information. Q: Hi Lee. Looking ahead to your possible Credit Spread service, could you explain a bit more about the bottom line? I understand the impact on margin, but I'm curious if the likely profit per trade would be the same as a comparable put selling trade or would we have to do more trades to achieve the same net? Separate from that answer, would we do more trades within a year? It's my understanding we would have a choice to either do the credit spread or sell on put on each trade. Are there enough potential choices for you to provide separate (not the same underlying stock) credit spreads and put sales to consider? A: Most likely we will launch this service in January. As noted previously, the new service will be called Vertical Spread Trader and will focus specifically on selling put-option credit spreads. I'm envisioning the spreads will collect roughly the same amount of premium as we do with the single put-sell trades. Doing so will give us the largest cushion we can expect when selling spreads. You need to remember, that when trading spreads, the premium you receive from the sold option will be diminished by the premium paid on the bought option. In most cases, because of this, the strike prices used in the spread will put you closer to the current stock price, versus when selling single put options which can give you very large cushions for error. That point is not meant to diminish the effectiveness of selling option spreads. It's just meant to make you aware of how they work. The trade-off with selling spreads is the same as with single put-sells: do you want a higher premium payment, or do you want more cushion for directional error? Also, and this is important, spreads give you a finite limited-loss feature in which you know upfront how much your maximum loss can be no matter how far the stock may fall. This can give peace of mind, especially when things are as erratic as they are now in the stock market. I do foresee having more potential trade opportunities with the spreads as we can concentrate on higher priced stocks. With Smart Option Seller, we try to stick with stocks $50 and under. This won't be the issue with the spread service. Q: Re: credit spreads - what happens if both puts get put? A: If both options in the spread go in-the-money, the short put would get automatically assigned and the long put would automatically get exercised.
They would offset each other and disappear from the account. Maximum loss would be realized.
Q: Hi Lee- So ready to get started. Do you still like the AMD $15 Feb 19 Put after the last few days vol? A: Hi, thanks for the question. Although I can't address individual investment questions, you can always check the instructions in the Current Portfolio that comes at the end of each of these alerts. At the moment, AMD is still open for new trades, but Alcoa (AA) and Big Lots (BIG) have been moved to no new trades. Well, that's all for now. I know this alert is longer than usual. Continue to hold all other open positions as-is. Contact me here with fills, comments, questions or concerns. Have a great weekend! Regards,
Lee Let's Grab That Cash!