Selling put options on Index ETF

Hi everyone,

This is probably one for the more geeky investors:
While studying for the CFA I came across the strategy of selling put options on stocks that one anyways intends to buy if the price is considered “right”. The rationale is that if the option does not trigger, we earn the premium. If the price of the stock goes below the option strike price, we have to buy the stock for the strike price which is however a price at which we would anyway have intended to buy, lowered by the option premium. In that sense, it is superior to a limit buy order and perfectly suited for people that e.g. periodically buy an index ETF in the wealth generation phase (i.e. the downside scenario is what we anyway do).

Now my question: has anybody done this in here in CH and on Swissquote and has some practical insights to share?
I had a look at the quotes for options & underlyings. Based on my investment strategy i could either sell options on VT (as I buy VWRL periodicallly) or the SMI (as I buy SPI ETF but SMI is the closest underlying on which you can sell options). I know how it works in theory but in practice I fear there could be some pitfalls that I’d like to avoid.

First, If you sell options on VT or CSSMI, this is what you get assigned in case they go ITM (this can happen before expiration). This makes no sense if your portfolio consists of VWRL and an ETF for SPI. You should convert.

Second, 1 option is for 100 shares so 100x VTI @ $155 = 15500 USD. Make sure you have the liquidity for that purchase.

Third, issuing options may make you a proffesional investor in the eyes of the taxman.

Hi glina,

Thanks for the answer.

  1. I thought that with options in reality what happens is that you settle the difference between market price and strike price and you don’t get the actual underlying assigned. In such a case selling options on an underlying that is perfectly correlated would work too, right? But the timing risk you mention is something i had in mind: i.e. the option is exercised and you manually have to buy as quickly as possible before the price of the underlying goes up again.
  2. so 1 contract on Swissquote is always on 100 underlyings?
  3. and the implications are?

I think this refers to the Option in general, not to Swissquote. From Investopedia: “A stock option contract typically represents 100 shares of the underlying stock

E.g. tax on capital gains. On the forum you will find many threads on the topic

  1. What you describe is buying options and trading them. If you buy a put or a call option, you can sell it for a loss/profit, let it expire worthless or execute it at any moment when it is in the money at your own will or automatically at expiration.
    When you sell (issue) options, you get the premium immediately and the buyer can excersise them at any moment when in the money. This means you get a put or a call, so in other words somebody puts 100 shares in your account at your option price, or you get called to give 100 shares from your account at your option price.

  2. Anywhere, not only Swissquote.

  3. Options are advanced financial instruments. You are only allowed to use them to manage risk for assets in your portfolio or risk being qualified as a professional trader.

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This strategy of buying securities is called Cash Secured Puts. I’ve started using it recently (during the recent crash even!) and if applied carefully and with sufficient cash at hand, it’s a nice way of lowering your purchase price (or getting a premium instead of dividends while the price of your security is still too high in your opinion).

It’s definitely not for beginners, though …

I’d recommend reading up on it in detail first in order to optimise your premium by taking into account the various parameters like the intrinsic and time value, historic and implicit volatility, the various price sensitivity parameters (the most important ones IMO are the delta, the gamma and the theta). Familiarize yourself with what is called the the OptionChain, get an understanding of what Open Interest is at the various strikes and expiry dates weeks, months, and quarters out (e.g. every 3rd Friday each month is one of the key dates where large institutional players buy such Puts. Customise your Swissquote OptionChain view to have the parameters mentioned included. Maybe you even want to experiment with a demo account first to get a feeling for how well you sleep with options ITM (In The Money, aka the current price of your security maybe way lower than the strike you sold with the PUT) expiring only in a few weeks or even in a quarter or two …
I can’t recommend a book on the topic as I picked up my knowledge on this as part of a course that’s not public.

As mentioned by others, the lot is always 100 shares, and for American style options they can be exercised any time by the buyer, and for European style options, they can only be exercised at the expiry. American style options are the common ones.

Last but not least: I would really really recommend having the cash (not just the “liquidity” aside for when the buyer strikes, i.e. not sell those options with a margin or seemingly backed with what you believe to be “liquid” assets (really embrace the Cash in “Cash Secured Puts”).
To illustrate this: what we observed in the recent meltdown is that some “safe” assets went down along with risky assets because there were account holders with large margins – when everything crashed, their brokers suddenly wanted more security for their money lent. Since the risky assets were already down, some account holders were forced to either feed fresh cash into their account or sell their “safe” assets to cover the gap (and hence these “safe” assets went down, too – even gold!).
A friend of mine with ~400k invested and about 80k liability on margin open (previously priced at a fraction of the liability) due to Cash Secured Puts was forced to add cash in the order of 50k with a day’s notice or his assets would have been sold for that sum (at the worst price possible) to cover the newly priced margin. Luckily, my friend was able to cough up the cash, but many others in the market were certainly less fortunate …
I guess this is general advice, not just for options. :slight_smile:

Also understand that on the options trading market there’s a few more pros swimming left and right of you than in the direct security trading market. Good luck with swimming in the shark pond … :wink:

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Hi Your_Full_Name

Thanks for your reply, very helpful!

Indeed, this is what I am after. Are you selling those on Swissquote or another broker?

While I have some reading to do, I am definitely not a newby (have a Msc in Finance and work in corp fi) and even had the pleasure once to memorize the black scholes formula xD It’s just the practice that I am lacking.

Regarding the greeks: correct me if I am wrong, but if I sell a put my max exposure should always be -strike price +market price where in an extreme case where market price goes to 0 my negative outcome would be the loss of the strike price as I have to buy a worthless asset for the agreed strike price. So if I put up cash amounting to = nr of contracts sold * 100 * strike price, then this is the max amount I can lose and therefore can be asked to put up as margin. I’d anyway only take exposure that I can absorb even in the worst case with the cash that I have waiting on the sidelines (i.e. that I plan to spend anyway on purchases of the underlying). No margin or collateralization with my other invested assets.

May I ask whether you sold puts on individual stocks or on ETFs? And what gets settled is the diff between strike - market price, right? I don’t get “physical” delivery (which I assume would trigger more transaction costs). In terms of transaction costs, is there a minimum of contracts that I’d need to sell in order for my premium not to be eaten up by trans costs? Looking at VT eg. which is today at rougly USD 74, I’d probably only sell 1-2 contracts because this would mean a worst case scenario that I could absorb without sleepless nights (e.g. at a strike of USD 68 the shortfall is 2x100x68–> max Armaggedon loss of 13.6k which would only happen when the end of the world is near given that the underlying is VT).

The other thing that came to my mind is the timing issue. VT options are traded on a US exchange so I assume these are american options which can be exercised at any time when they are ITM. The theoretical assumption in the context of the investment strategy is that the underlying is bought immediately when the option is exercised which, if only the difference is settled doesnt happen automatically. So in practice, if I sell an american option, as soon as the option is ITM I need to be prepared to buy the underlying at any time. Otherwise, in the worst case the option is exercised and I could miss the opportunity of buying the underlying at a cheap price. Which is why I like the idea of a european option more but that leaves me with the SMI as underlying which is traded in pieces that are to big for me to absorb risk wise. Does my train of thought make sense?

Hey @Gojuryu

If I gave you valuable advice, I would probably charge you for it. Here’s some free advice instead, please price it as you see fit. :slight_smile:

I’ve started selling Cash Secured Puts on Swissquote, mainly for historical reasons (IB seems more reasonable these days). Cash Secured Puts on IB seem straightforward, though that’s only what my friends say.

I’m afraid I won’t be able to anwer your question regarding selling a put with your considerations of “the greeks”. They’re important, but a correct-me-if-i-am-wrong note is not one that I can provide.

I’m afraid the only last definitive answer I can provide to you that I sell put on individual stocks.

I feel you’re much further ahead of me on the theory of things in this space, and I wish you all the luck that is to be had!

Oh, maybe on your settlement question (for options ITM): afaik you get physical delivery of the securities at expiry. I don’t believe you’ll have transaction costs on this delivery at Swissquote, but I have not experienced an expiring option ITM yet. There’s one possibly in these conditions by June 19, so I might be able to tell you more the week after.

And regarding your max exposure, yes that’s 100 x strike (minus the premium, to be pedantic).

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I’ve been using that for a while. I had the money, I was selling put options for a price that for me was good and a bit far away from the price. Always a short time, around 1, 2 months. Always around 100, 150$ prime.

Until… the last crash :face_with_raised_eyebrow: :face_with_raised_eyebrow:

I wanted Delta Airlines and I sell, let’s say at 100$. I had the money, nothing margin. But… When the stock down to 60$… Well, I had 10000$ “blocked” that I couldn’t use to make other interesting buys!!

Of course, they where blocked because I didn’t want to buy back the option and lose all the money.

I was close, close to use the margin because was insane having in cash 50k$ and being blocked to so high prices and without having the posibility to buy anything else. All that, for 100$ of prime I got.

My 2 cents:

  • If the market is more or less stable, is a good strategy (just be aware about being considered professional ).
  • If the market is moving a lot and you didn’t start the strategy, is the best moment for using options. They pay a lot because the volatility.
  • Think that you are “blocked” either in cash or in margin for a lot of money 100 * ETF value.
  • Last… Be careful with options in GB, they are 1000 stocks!!! :wink:

Regards.

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I was lurking this post because I found this idea intriguing.
Basically if you have VT at 74 and you have ~7300 dollar on your account you can sell a put for next week at 73 for…how much? 10 dollars? 5 dollars? I have no idea how much.

What will basically happen is that someone buys that option from you and gives you that 5-10 dollars. If before next week VT goes to 72, that person will sell you 100 VT at 73 (IB/SQ will make the transaction automatically I believe).

So if you want to buy VT anyway, this way you might either buy VT at a slightly different price than expected ( we shouldn’t “expect” any price, we just buy in the accumulation phase, no big deal) OR you make that 5-10 dollars and try again.

This is how I understand the whole story.

I don’t understand though what it means that @Tino transaction get blocked though.

Regarding the risks of being considered a professional trader, as long as you are in the accumulation phase you surely don’t make enough money from those trades to surpass your normal wage, so it’s not a big deal. If you might have 100 or more of such trades maybe they might investigate. Who knows.

1 Like

@ma0

Selling VT Puts with strike 74 would momentarily garner you

  • over 100 USD with expiry on June 19
  • over 200 USD with expiry on July 17
  • over 265 USD with expiry on August 21.

With strike 73 the amounts are 80, 175, and 240 USD, respectively. If you wait for days with more volatility than this week so far, prices for these puts will go up significantly.

@ma0 exactly that was my plan. But again, this is theory. In practice you have transaction cost which will probably eat up some of your premium, making it maybe not worth the risk, the issue of whether you really receive the underlying or only the difference is settled and you would basically need to buy the underlying as soon as the option is exercised and maybe other “frictions” which is why I wanted to leverage the experience in this forum.

As far as the blocked transaction is concerned: in your example the USD 7300 or a fraction of that (depending on the ITMness) is blocked as margin by the broker to make sure that when the option is exercised you have the necessary cash to settle, which then obviously you can not use for other purchases.

Ah Ok. Well it’s still a gain anyway and with IB the costs would be very low, so it’s still a win situation. On a 2 weeks option of 100chf I think it won’t be bad. Also you block the money for 2 weeks only and with the goal to buy the same ETF anyway.

Again, it’s not a way of optimize, just a way to make a tiny bit more money.

Or maybe it’s just a game.

Hi ma0,

Blocked money is a kind of speaking. If I buy the put, problem solved, but when the stock go down, let’s say 3000$ the put also.

Now, with options you get or pay the incertitude in the future.

If you have the VT at 74 and want to sell a put for the next week at 30, probably nobody is going to buy your put because the probabilities are practically 0.

Higher volatility -> Better prime.
Longer expiry -> Better prime.

All is normal. A fund that have VT now from clients can say, we pay 100$ each option but we assure that somebody is going to buy them in the future if the value go at… let say, 72… and so on.

The thing is that you are going to get the stocks in the future, that’s for sure. But if you want to have a decent prime you must go far away in the date and that can be really annoying.

I know people that are “chasing” stocks or ETF for months or years! Just selling the puts too far in date, OTM. Normally they are not executed but if they are, they had the money.

Is like having dividends without paying taxes :wink:

Regars.

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I can’t really read it well but I suppose it cost 0.90 x 100 = 90 usd for a put at 46. Not sure what’s the ask price though.(and the rest stuff is also unclear to me).

Well, I’d sell that option myself. If something bad happens, before november 20 I’ll have 100 VT at 4600 usd +/-. If not, I’ll have 90 usd more.

Of course if I get the ETF, it means it might be worth 45 or less at that point, meaning that I’ve lost 100 usd, but the fact that I’d do it with VT means that I believe in it and that I’d buy it anyway.

Thanks for the insightful discussion!

My takeaways are:
lot size is 100 shares per contract
have the cash available to absorb the risk
if practiced infrequently, gains too low for trader to be considered professional
if not professional, then the option premium is a tax free gain

Not necessarily. It’s just a way of calling them. In fact, according to Wikipedia (I know, THE source):

Option contracts traded on futures exchanges are mainly American-style, whereas those traded over-the-counter are mainly European.

Nearly all stock and equity options are American options, while indexes are generally represented by European options. Commodity options can be either style.

Very interesting thread! Thanks @Gojuryu!
This topic of selling options (both puts and calls) has been consuming me for some time now, so here are some of my ideas.

First of all, like the majority on this forum I’m a buy and hold for the long term investor. I was also considering using the VT ETF at first, but then came to the conclusion that a combination of VTI+VEA+VWO (50%, 40%, 10% respectively) has more advantages. One of it would be that, in case one has a significant amount to invest (say anything higher than $10k), instead of going for the DCA or VCA one can employ a different strategy adding short put options to the mix. So, in this scenario, my idea is to sell 1 VEA Jun19’20 40 PUT @ 0.50 and collect a total of $50 (total cash after tranzaction: $10’050). If the price at maturity will be higher then 40 for VEA, then the option expires worthless and one gets to keep the premium (total cash on 19 Jun 2020: $10’050). However if the price at maturity will be less then 40 for VEA, then one will have bought 100 VEA shares for $4k (total cash on 19 Jun 2020: $6’050). In this ITM scenario, and assuming there’s a correlation between VEA and VTI/VWO share prices, at maturity the prices of VTI/VWO would have dropped too (say a second wave o covid-19 is confirmed and new lock-downs imposed) so one can use the remaining cash (i.e. $6’050) to buy the corresponding VTI/VWO shares much cheaper then what would have paid if going all in now. Of course the downside of this strategy is if the prices keep going up no mater what then one would lose the opportunity for buying cheaper now (in this case, better go all in now and don’t complicate your life).

The other idea I had, with regards to selling calls, i posted it some time ago here. And to expand on it a bit, I think it could work as a strategy for re-balancing the VTI+VEA+VWO portfolio.

Super keen on hearing what you guys think about it.

Very interesting concept. Could you expand a bit on it pls?

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