My thoughts on CSPs (and a little bit on CCs; so, the Wheel)

Hi all, someone asked me in chat my thoughts on selling Puts, and margin and assignment, and what I wrote back got long, so I thought others might glean something from it. No need to read this if you're fairly familiar with CSPs.

TL;DR: Only sell CSPs on tickers you'd genuinely BUY ANYWAY. "Juicy premium" is not a thesis. If you get assigned, sell CCs at your cost basis to exit, or at 30-delta to keep the shares. Rinse and repeat.

I've been doing options for a bit over 5 years now, and that doesn't make me any kind of expert, but I've done just about everything you can do with them and been through a lot of different scenarios. And just so you kind of know who I am before I go spouting off, I'm 62, a Nuclear Engineer, and have been investing/trading/playing in the stock market since 1992. Mutual funds, stocks, ETFs, and now options almost solely for the past 2 or 3 years.

You probably know that selling a CSP is the simplest thing you can do with options, and everyone should start there (other than CCs for some, which I'll get to later).

Say you like SOXX right now because it's up 88% in the past 3 months and you want some of that action. (Btw, I always recommend ETFs: much safer than individual stocks.)

You could buy it outright and maybe catch 88% over the NEXT 3 months.

But if you're going to buy it anyway, why not sell a CSP right ATM? And I do mean RIGHT at the money.

Watch:

SOXX closed at 639.45 Friday, call it 640. (I know it's expensive, but just follow along with the math and apply it to the ticker of your choosing.)

Next Friday's 640 Put is selling for 23.30 at Midpoint.

What's the ROI on that?

It's 23.30 divided by the $640 (per share) collateral you have to have (unless you have a margin acct, then you may only need 1/3 to 1/5 of the collateral; take advantage of that, but don't overdo it).

That's 3.6%. In a week. For a ticker you were going to buy anyway.

That's one use case for Puts: buying a stock you were going to buy anyway.

Another use case is to earn a return on your money.

What if you sold that ATM CSP every single week and never got assigned? Do we get to multiply by 52 weeks? Pretty much, kind of. At least to get a feel for how much return that really is. It's 189% apy.

Is that bigger than getting 88% every 3 months for SOXX shares, like it's been doing? No, not by a long shot. But assuming it keeps up that pace (and I know that "past performance doesn't predict future results"): 88% 4 times in a row (not compounding) is 352%. Hmmm, better off buying shares.

But wait, remember margin, and how it decreases your Buying Power Effect (or whatever your broker calls it)? Hmmm, say you get 4:1, then you get to multiply that 3.6% per week by 4 because they only hold one-fourth of your money in escrow. Then that becomes 14.4% per week. And all of a sudden that IS larger than 88% in 3 months.

But that margin multiplier cuts both ways, so be careful with it, and ensure you understand it.

I gave a lot of mathematical detail there with the ROI, but I want to make sure you see it; it's powerful, especially if you have margin.

Selling a CSP on A TICKER YOU WANT TO BUY ANYWAY, is 'better' than simply buying it. Because you get paid to buy it.

If SOXX closes the week below 640, you'll buy it there, but you would've bought it at 640 anyway, so.......so what?

Now what's your CB? It's Strike minus Premium: 640 - 23.30 = 616.70. And that's a 3.6% discount. (The same 3.6% we saw before.)

So if you were going to buy SOXX anyway, then selling the CSP puts you in a better position NO MATTER THE OUTCOME on Friday. Either you DON'T get assigned and make 3.6% for that week, or you DO, and you buy SOXX at a 3.6% discount.

And if the price ends up lower than your CB? So what!? YOU WERE GOING TO BUY IT ANYWAY.

Now reevaluate your thesis for SOXX: if you don't think it will go back up, get rid of it. (And of course, you do that with a CC; more on that in a minute.)

But where people get in trouble with CSPs every single time, is when they say, "I wouldn't mind owning SOXX at 640."

See the difference?

"I want to buy XYZ because...." is a very different statement than, "This premium is so juicy, I really wouldn't mind owning ZYX at xx.xx."

But you WILL mind owning it when it gets put to you below the CB, I guarantee it.

Want to do a CSP on something like IONQ with its 109% IV? Go ahead, at-the-money you'll make 4.8% this week. But don't cry when it drops 22% like it did the first week of June. That \~5% you made on the CSP won't feel like much buffer against a 22% loss.

And then do you hold because you think it's a quality ticker that should go back up soon (like SOXX)?

Or do you bail with a 17% loss? Or do you try to sell CCs at your CB for much less than that 5% per week?

Selling Puts comes down to really TRULY believing the ticker is one you'd BUY ANYWAY. Because sometimes you WILL be forced to buy it, so you'd better be okay with that outcome.

A quick note about assignment: if it hasn't happened to you yet, it's scary the first time or three. But just remember this: you're not really in the hole $64,000 (SOXX) or whatever (if you used margin; if not, then you actually paid 64k for the shares).

You're only \really\** on the hook for the difference between the strike you bought at, and Monday's price.

So Monday if you want, sell those same shares at the market price, and you're flat again.

Or keep them, because that was sort of the plan: you were going to buy them anyway.

If you get assigned, sell a CC at CB and you'll get paid to get out (3.4% this week for SOXX), or at 30-delta or so if you kind of want to keep the shares and participate in possible appreciation.

And CCs are THE safest thing you can do with options. You can't do any WORSE than you'd do just holding the shares. All that can happen on the upside is that you have to sell your shares at a price you might later regret.

But don't: you made that deal with the market, and the market took you up on it.

Go back to the Put side. Same ticker if you want, or another.

And this is what I alluded to earlier, that some might start on the Covered Call side. And that would be because they already own 100-lots of shares of something they wouldn't mind selling at a certain price.

And just like Puts, that's probably the main use-case for Calls: to sell shares you own, and get paid to do so. (Divide the Premium at your chosen strike by Spot to get ROI for the period.)

And again, just like Puts, another use-case for CCs is to earn an ROI from the premiums. If the shares happen to get sold in the process, that's alright, just sell a Put to either get some more shares (so sell ATM), or to earn an ROI (then maybe sell at 30-delta).

I've been talking about Weeklies here just to illustrate the possible ROIs, but we should probably stick with "the TastyTrade way" of selling 30-45DTE options. They say 30-delta on both sides, but I sell ATM on the Put side, and at CB on the Call side, because I want to maximize return. And I really lean on 30 days, even 4 weeks/28 days if it's the weekend and I'm setting up trades for Monday.

But when selling Puts, by gosh, MAKE SURE it's a ticker you'd TRULY want to own.

DON'T let high IV and thus high premiums make that decision for you.

I showed with SOXX, which isn't too terribly volatile (though it does have an IV of 77% for this week), that you could theoretically make 189% apy selling CSPs and maybe never own a share.

Just the way I do it.

Play safely out there,

Mike in Atlanta