There is a recent trade huge option trade similar to the Buffet’s previous 2004 ~2007 trade. Here are the things that I learn from this recent trade,
Summary of learning,
- sell put options is good income strategy
- need margin account to reserve cash for the options. Can buy buy some put options (when put premium drops) to free up cash reserve.
- can be used when I have large sum of cash for reserve
- if I want to sell OTC super long term put options, I need to find the special broker to help me, maybe I need a professional account?
- can be used for hedge in my portfolio
- look forward to days where the market drops 1~2% as a result of panic-induced global selling. This is usually the best time to sell put options since volatility (aka fear) is at a high.
Selling Puts – video lesson from Etrade
This options strategy is referred to as the cash-secured put.
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Find a stock (or ETF) you would like to buy.
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Determine the price at which you’d be willing to purchase the stock.
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Sell a put option with a strike price near your desired purchase price.
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Have on deposit in your brokerage account an amount of cash equal to the potential obligation.
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Collect (and keep) the premium from the sale of the put, while you wait to see if you will buy the stock at the lower price.
Anonymous Buffett-like bet on S&P 500 causes a stir on the options market
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An anonymous trader sold 19,000 put options on the S&P 500 Index on Monday, causing a stir in the U.S. equity options market.
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The bet recalled Warren Buffett’s famous wager on global stocks more than a decade ago, when he sold billions of dollars in stock index options between 2004 and 2008.
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While Monday’s sale was nowhere near as large as Buffett’s, the trader could still lose more than half a billion dollars if stocks turn sour over the next couple of years.
The trader sold 19,000 put options on the S&P 500 Index obligating him or her to buy the market benchmark at 2,100 on Dec. 18, 2020, data from New York-based options analytics firm Trade Alert showed.
As long as the index doesn’t drop more than 22 percent from its current level of 2,582 by that date, the bet will earn the trader roughly $175 million in premiums.
While Monday’s sale was nowhere near as large as Buffett’s, the trader could still lose more than half a billion dollars if stocks turn sour over the next couple of years.
For example, if the S&P 500 loses 34 percent of its value by Dec. 18, 2020, the trader will rack up a loss of about $558 million, according to a Refinitiv analysis.
Some market participants guessed the trader was likely hedging against another position rather than betting outright that stocks will rise.
“The natural sellers of long-term downside puts are structured products desks at banks, who are hedging exposure they get from retail clients who buy structured notes that have embedded short put options,” Benn Eifert, chief investment officer at QVR Advisors in San Francisco, said on Twitter.
Buffett,
There is an oft-used quote from Warren Buffett’s Berkshire Hathaway (BRK.B – Get Report) annual letter from 2002: “In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”
While the letter does, in fact, say this, the exact same letter also says: “Indeed, at Berkshire, I sometimes engage in large-scale derivatives transactions in order to facilitate certain investment strategies.”
2004 to 2007: From 2004 to 2007 Berkshire sold puts in just about every major index… in effect Buffett went long the world (he probably wishes he has waited a few years). He sold long-term OTC European-style puts that expired in as little as 15 years, but most were in the 20 years to expiration range. The main idea of the sale of these puts was that while the market might have a downtrend here or there, over time it just goes up… and he has been right. In total, Berkshire collected premiums of around $4.5 billion dollars on the puts it sold. The bet: the markets worldwide would not completely tank for the next 20 years. Not a bad trade
2008: In 2008 as the market was tanking, Buffett sold more of these puts in SPX and a few other indexes. In addition, during the financial crisis, Buffett again engaged in derivatives — notably buying $5 billion preferred stock in Action Alerts Plus holding Goldman Sachs Group, Inc (GS – Get Report) that had warrants (options) to buy Goldman Sachs common stock.
Selling put options is a great way to generate income. I use it extensively in my portfolio to get a consistent stream of income.
You can be lazy: Once you committed to a put option, there’s not much you need to do. You can monitor the underlying stock once or twice a day and that will be sufficient. For the most time, you can sit back and watch the passage of time do the work for you since time decay will gradually decrease the value of the put option.
When sufficient time has passed, or when the market moves in your favor, you can consider buying back the put contract to free up your capital. You can then deploy your capital by selling put contracts on another stock.
You look forward to market downturns: Perhaps this just applies to me only, but I look forward to days where the market drops 1~2% as a result of panic-induced global selling. This is usually the best time to sell put options since volatility (aka fear) is at a high. I would scour through my watchlist to find stocks that are being oversold, and sell puts with strike price near a support line. As volatility drops over the next few days as the market gains equilibrium again, you will be left with a small gain in your positions.
You can make use of your margin: You will be required to put up some capital as margin when you sell put options. The margin requirement varies with the underlying price and options price, but will typically be capped at the strike price * 100 per contract. So if you sold one $20 PUT option, the maximum margin requirement you would expect is $2000 ($20 * 100). Does this mean you must have cash sitting there idly?
You can actually invest a portion of the cash you put up as margin into low-beta dividend paying stocks or ETFs to earn an extra 3~4% yield per year. Being Canadian, a portion of my margin requirement is made up of dividend-paying stocks such as Rogers Sugar and interest-paying bond ETFs such as Canadian 1-5 year corporate bond fund. This more than offsets my trading expenses, and leaves me with some nice pocket change.
Keep in mind that for a typical margin trading account, 30% of the equity value will be added to your initial and maintenance margin, leaving only 70% of the market value you can use to offset the margin requirements of your put options. I would recommend keeping a portion of your margin requirement in cash (30% at least) in case the underlying stocks or ETFs you hold suddenly lose value along with the rest of the market. The last thing you want is a margin call during a market downturn.
Selling Put Options: How to Get Paid for Being Patient
