Our Senior V.P. of Research on the 3 factors of an ideal put-sell candidate
Put options are usually thought of as bearish trading vehicles. However, puts can be utilized for bearish, bullish, and directionally neutral trading strategies. To gain more insight on the subject of put selling and all it has to offer, I spoke with Schaeffer's Senior V.P. of Research Todd Salamone.
We issue at least two put-sell recommendations in our monthly Option Advisor newsletter. What indicators do you use to find attractively priced put-sell candidates?
TS: I prefer to recommend put-sell trades on stocks that just had earnings and reacted well to the report. If I do this closely to the report, I will sell as implied volatility on the options is working its way lower. In general, I look for stocks that are in good technical shape, and that have good upside potential with minimal downside risk when observing the chart and the sentiment backdrop.
What's the best time frame to sell puts? Why?
TS: A better question is, when is the worst time to sell puts? The worst time to sell puts would be ahead of earnings or another key event, and when the stock at risk of reacting negatively. The reason is, unlike buying options, your reward is limited to the premium received, but your downside risk is a multiple of the potential reward.
To answer the first question, the best time to sell puts on an underlying is when there is little to no event risk during the holding period, but you can receive an attractive premium relative to your assessment of the underlying’s maximum pullback potential. Yes, ahead of events, premiums are "jacked up," but sometimes it is for a reason, and you don’t want to be on the wrong side of the move unless the payoff is significantly more than the risk you are taking. I learned my lesson on this several years ago, when selling puts on a biotech company that a few days later did not get FDA approval for a new drug.
When/why would you sell a put instead of buy a call?
TS: Sometimes I will do both, but, generally speaking, if I see a stock that has a history of chopping around after earnings, or I think that both the upside and downside is limited, I will opt for the put-sell trade. When I buy options, I am looking for a big move in underlying and profits of 100% or more in exchange for accepting the additional risks that I am taking on, including time decay risk.
What would deter you from recommending a put-sell?
TS: An event on the immediate horizon that could spark unusual movement in the equity. Or, on some stocks, since I like to recommend out-of-the-money options, the stock price may not align with the strikes offered. For example, if a stock is at $54.50 and the next out-of-the-money strike is at $50, the premium I collect, especially on a non-volatile name, may not be enough to justify the risk.
Could you describe an ideal put-sell candidate, from an Expectational Analysis point of view?
TS: The ideal put-sell candidate would have three things: solid earnings reaction; the potential for upgrades by analyst community or the shorts to cover; and evidence of strong support on a chart that is above the sold strike.
What should an options novice -- perhaps someone who has only bought "vanilla" calls and puts -- know about writing puts?
TS: "Don’t sell what you cannot afford." Remember, when selling puts, you are taking on the obligation to purchase the stock at the strike price if the equity is "put to you" by the put buyer, who has the right to sell the stock to you at the strike price. Each contract that you sell represents 100 shares of the underlying. So, if there is a chance that you might be obligated to purchase 300 or more shares of the stock at the strike price because you wrote three put options, but you are not comfortable or cannot afford that many, consider writing only one or two put options. In other words, do not over-commit.