Friday mailbags give me an opportunity to answer a few questions from my subscribers – I enjoy the fact that it could be of help not only to the person asking, but to other curious minds as well.
I hope these two questions and answers will help clear up some confusion about covered/uncovered put options… And clarify a “stupid” question that I believe is actually a smart one.
So, let’s open today’s mailbag…
Dear Jeff, my brokerage account is with TD Ameritrade, and I am approved only for Tier 2 activity…
While I don’t foresee myself selling uncovered calls, as it just exceeds my risk appetite, I realize that selling uncovered puts is one of your key strategies for generating income, and if I understand correctly, it makes up 1/3 of the overall options strategy you posit.
Can you advise how this affects my potential in building an effective trading portfolio step-by-step? I’m concerned about not being able to consider 1/3 of the overall strategy. Grateful for any insight you can provide.
– Christopher
Hi Christopher,
As a trader, the more tools you have, the better your chances of success. If your only strategy is to buy speculative call and put options, then you’re kind of like the handyman who only carries a hammer. You might be able to get the job done. But, it would be a whole lot easier with a few more tools in your belt.
Selling uncovered put options is a crucial part of an option trading strategy – because we can use the premiums received from selling puts to pay for the speculative options.
For example, I turned bullish on the financial sector a few months ago and I recommended a speculative call option on the Financial Select Sector Fund (XLF). I was early on the trade (which I often am), and the position lost value.
It wasn’t necessarily because XLF was going in the wrong direction. It wasn’t. The option lost value because it was taking longer than I thought for XLF to rally.
To make up for that loss, we sold an uncovered put option on XLF. The premium we received from that option was more than enough to pay for the original call option purchase.
In other words, we used a conservative strategy – selling uncovered puts to pay for the more speculative trade – buying call options. By doing this we created a situation where even if the call option expired worthless, we’d make enough on the uncovered put option to profit off the combined strategy.
As it turned out, XLF finally did rally and we closed both sides of the trade for a profit. But, that’s not always going to happen. Speculative trades don’t always work out.
My point, though, is that if you can sell uncovered put options and use that money to pay for the speculative trades, then you’re more likely to succeed as a trader.
So, I encourage you to do whatever is necessary for your brokerage firm to approve you to sell uncovered puts.
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Probably a “stupid” question, but thanks to you, I recently sold my first uncovered put. It’s exciting and terrifying at the same time. But I digress.
Your October 26 recommendation didn’t mention if there’s a maximum I should sell it for. That’s where I have a question…
Given the most likely scenario is for the option to expire worthless, and given I get to keep the upfront premium, aren’t I better off with a higher premium?
In other words, if I could manage to receive $1.00, instead of $0.85, isn’t that a better deal since I collect a higher premium? Thanks for the answer (and the knowledge needed to complete my first trade).
– Mike
Hi Mike,
Lots of folks like to say, “there’s no such thing as a stupid question.” Having taught college-level finance classes for many years, I can assure you, there definitely is such a thing. Your question, however, is not stupid.
Option prices are volatile. And, between the time that I write up my recommendation and the time at which you can act on it, the price often changes. That’s why I specify the maximum price you should pay when I recommend buying an option, and the minimum price you should receive when selling an uncovered option.
If the price moves so that you can do even better, then, by all means, take advantage of it. In the case of XLF, my recommendation was to sell it for $0.85. If you can get more (like the $1.00 you mentioned), then you’ll have an even better risk/reward setup on the trade. And, you stand a chance to make even more money.
Best regards and good trading,
Jeff Clark
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Reader Mailbag
In today’s mailbag, we’re sharing the influx of various emotions and opinions in response to Jeff’s Monday mask essay…
Hi Jeff, thanks so much for your daily read. I agree with your theory and I smile under my mask. I have discovered that young children know I’m smiling at them and they always smile back. I love it! It’s probably because I’m old enough to have these little crinkles around my eyes when I smile.
I truly enjoy your daily emails… Thanks for sharing more than just finance with us. Have a wonderful day. A loyal reader.
– Sandra
I wear a mask because it’s a small price to pay for possibly decreasing the severity of the pandemic. I am a 65-year-old physician. I smile behind my mask and look for the sparkle in the eyes of the recipients. Thanks for the opportunity to share.
– Mark
Jeff, I want to say that your article on masks and assuming the best from people is the best article that you have ever written. I’ve read many of your articles since becoming a subscriber to one of your services. Keep up the good work.
– Harry
I’ve found the exact opposite. People seem much more friendly since the pandemic. The mask is a symbol of our common commitment to protect the most vulnerable in our society. Perhaps I live in a more caring community.
– David
I miss hugging my grandchildren the most.
I also miss a rational, sane approach to relating to the pandemic. I miss a balanced look at the real science. I miss the dialogue about any of the “orders for your own good.” I miss the uncountable small businesses that are being forced into bankruptcy.
I miss all those uncounted extra folks who die as a result of the neglect of their heart, lung disease, cancer, missed surgery, suicide, overdose, or are murdered in the current fear-driven panic. And, especially, I miss those elderly who “merely” die of a broken heart.
– Eric
… And for the more politically-minded opinions…
Hello Jeff, I was surprised and happy to see your email about the masks. I’m in total agreement – also living in California. In fact, I did a speech on it in our Toastmasters Club. We as humans need that humanity from others. Following the words of L. Ron Hubbard, we need shared affinity, reality, and communication from others. We need those to survive.
I’m glad there are others who see this as I do. I’m a tutor and I especially see the destruction of the children’s sense of well-being. This “social engineering” experiment is not going well. I’ll continue saying hi to those I meet on my walk, as you never know, maybe that old man hasn’t talked to anyone all day! Thank you for your wise words.
– Karen
For what reason does the Deep State want American citizens to view each other as enemies? Divide and conquer. Abraham Lincoln said our biggest threat would not come from without, but from within. And, here we are.
As far as “none of us can make much of a difference in this pandemic,” I was very surprised to see you write that… But, here we are.
– Gary
Thank you, as always, for your thoughtful comments. We look forward to reading them every day. Keep them coming – and send us any questions – at [email protected].