I don’t have many favorite option trading strategies, but one of them has to be selling puts at a market bottom. Now don’t get me wrong, the term “market bottom” can really only be used with accuracy when talking about what has happened in the past. None-the-less as a trader, that’s what we do. We speculate on whether or not we’ve reached a market bottom. We can’t help ourselves: it’s our plight. For the purposes of the educational nature of this discussion, let’s say we get to a point where we think we’ve reached a market bottom and we’re ready to put our money where our mouth is.
What does a market bottom really mean to us? If you really think this is a bottom, are you willing to buy here? If you, again, are willing to put your money where your mouth is I think the answer is “yes”. And, what does it look like going forward? For the year the market is down, what, around 30 percent give or take? What do we think will happen over the next month? Can we make back that 30 percent in 30 days? Maybe; but it’s not likely. More likely we’d have a small, but respectable rally of maybe 5 percent.
That brings us to our option strategy. Selling puts has a few benefits when you get ready to call a market bottom. Not that it’s without risk; but it can be a smart way to play this trading scenario.
When you sell puts, if the underlying security in question (for our purposes an ETF such as SPY, IWM or QQQQ) falls, you might get assigned on puts, in which case you buy shares of the underlying ETF. This, of course, is totally conducive the trading plan. That is, “if I think it’s cheap (i.e. a bottom) I’ll buy it”. (Again, not saying you can’t be wrong, but if you want to get long the market, here’s a way).
Now, let’s say the market rallies after selling puts. If it rallies a small but respectable amount, you have a winner on your put. The only caveat is that if the market does, in fact, stage a huge comeback, your profits are limited to the credit received for the put. That is (kind of) OK, too. Leaving money on the table might make you swear, kick and scream; but let’s face it, no one ever went broke taking a profit.
The real benefit here, though, is two fold. Not only are the (perceived) odds in your favor with an upside bias with the stock market at its lows, but implied volatility is through the roof! Selling puts after the panic is like selling fire insurance after the fire–and people are paying up!
Selling puts is a strategy that the faint hearted tend to use on stable “safe” underlyings to collect premium on a likely-to-win bet. Here, there’s theoretically more risk since there is high volatility. But when you’re ready to go ahead and take a stance, this can be one of the smarter ways to do it.
Dan Passarelli
Market Taker Mentoring LLC
