We can all agree that when we were first introduced to the world of options it was quite overwhelming. As much as I loved the idea of options and preferred them over trading stocks, I often wondered why there were so many options in options. Learning the greeks and understanding their meaning was one thing. Let us not even get into intrinsic and extrinsic values, ITM, ATM, OTM. Then came that whole options chain thing with a million expiration dates and strike prices to digest. I don’t know how anyone can navigate in the world of options without guidelines to at least assist them so they at least know where to start.
Once you get your feet wet, the pieces do eventually start to come together and as you remain consistent and gain confidence, the training wheels eventually come off and you left to make decisions based on your skill and style of trading. Let’s take selling options for cash flow and let us use the Naked Put strategy as an example. First and foremost, if you sell a naked put the assumption is that you are willing to take ownership of the stock. So first rule, only sell puts on stocks you are willing to own. Secondly, make sure you can afford to buy the stock. Meaning, that if the shares get put to you, you would need to have enough capital to acquire said shares. Even though the naked put strategy is an income strategy, your decision cannot solely be based on the amount of credit/cash flow you are receiving. Most of you know that when I was a new trader I was primarily a directional trader turned cash flow trader to fit my lifestyle at the time but even as a cash flow trader, I was still going after the money. The objective of selling options is to find that sweet spot where everything falls in place. As a beginner, one of the pro tips I got from coach Tim and still use today was to use the three C’s. Chart, Cushion, and Cash Flow. He described it as finding the Goldilocks scenarios. Not too hot, not too cold but just right. It’s finding something that is balanced with a good chart, enough cushion, and decent cash flow. Let’s explore each one.
Chart: Once you have decided which strategy to use, in this example the naked put, you then have to analyze the chart to see if it fits the strategy. For a naked put strategy, your bias should be bullish to neutral. I like knowing just how cheap or expensive the options I plan to sell are going to be right of the gate so I add the implied volatility (IV) indicator on my chart. Why? Simple answer, when IV is high, options are expensive, and selling puts or put spreads is attractive. When IV is low, options are cheap, and selling puts or put spreads isn’t that appealing. It’s an effective way for me to eliminate stocks with low IV because they won’t have enough meat on the bone.
Cushion: The delta rules for naked puts range between .05 to .25 Delta. The delta you choose determines the strike price you are selling. Therefore the delta connected to the strike is measuring the distance between the current price of the stock and the strike price. The further away the current price of the stock is from the strike price, means you are selling a lower delta. The closer the current price of the stock is to the strike price, the higher the delta. Cushion is a priority over credit received. If you can get enough cushion and still get enough money you take the cushion. You can use indicators such as the probability cone, support levels or moving averages to help decide if you have enough cushion.
Cash Flow: Remember when selling a naked put we are getting paid to take on the obligation to buy the shares if the price drops to the strike price we sold. So if we have to take on this obligation, the premium we are receiving has to be worth it. Use the playbook or spreadsheet guidelines for suggested ROI%.
The sweet spot of selling naked puts is to have enough cushion and decent cash flow with a nice-looking chart. Start by having a list of stocks you’d like to own. Analyze the chart and run the numbers using the playbook rules. Play around with the numbers and select what works best for you based on the general guidelines. To learn more join me tonight at 8:30pm est as we further explore selling naked puts using the three C’s in our Women In Trading Webinar. See you then!
Until next time Traders!
Emily Muiruri was born and raised in Nairobi, Kenya before her family moved to the US and settled in Maryland, Emily began her trading journey in January 2015 after 17 years of Property Management in the Self-Storage Industry. Like many new traders, Emily started off with directional trading strategies such as long calls, long puts and very little in cash flow strategies. Over time that has changed and now her core trading strategies are cash flow based such as are Covered Calls, Naked Puts, and Iron Condors. Though she is still a student learning and enhancing her trading skills, she has a strong desire to teach women to take control of their finances and become traders. Writing blogs is one of the ways she’s is looking to spread the word and get more women involved. Emily knows that with the right education and trading system women can be successful traders.
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