Here, here, here and here I have highlighted situations where exorbitantly high implied volatility levels have created opportunities to sell very far out-of-the-money cash secured put options. The underlying stocks that I have written about have continued to get crushed as the potential economic fallout from coronavirus hits home.
The good news is that either:
*at some point the carnage may actually let up and the options will collapse in price as implied volatility falls, OR
*the positions will end up buying the underlying shares at levels far below even today’s bombed out prices.
The status of each example position at the close on 3/18/20 appears in Figure 1
A = ticker symbol
B = Closing stock price on 3/18/20
C = Date the put option expires
D = Strike price of put option sold
E = Total $ premium received for writing 1 put option
F = Maximum $ risk per 1-lot (if stock price goes to $0)
G = % gain if option is NOT exercised ($ premium received / $ risk)
H = Effective price you would pay for stock if option is exercised
I = Difference between current stock price and effective purchase price
Figure 1 – Cash secured put trades
NOTES:
*Each of the stocks listed is presently in a freefall. Under no circumstances would I advise buying shares of these stocks at current prices in this environment. But the trades listed in Figure 1 would not buy these stocks unless they fell another 40% to 80% – i.e., rock bottom prices
*For each ticker, either a) the stock price will fall below the strike price or b) it won’t
*If the stock price DOES drop below the strike price, we may ultimately be required to buy 100 shares of stock at the strike price. However, our effective buy price (Column H) will equal the strike price minus the premium received.
*Column I tells us how far the stock has to fall to reach our effective purchase price. For example, if we ultimately buy, for example, ticker CCL, we will pay an effective price of $2.25 a share, which is -75.8% below the current stock price of $9.30 a share
*If the stock price DOES NOT drop below the strike price, the option will expire worthless and we will keep the entire premium received when we sold the put option (Column E). Our percentage return (Column G) will be the premium received (Colum E) divided by the maximum $ risk (Column F).
*The maximum dollar risk (Column F) is the amount of cash we needed to put up to sell the cash secured put in the first place.
*The % return achieved if the option expires worthless appears in Column G.
*For each of these positions, one of three things will happen. Let’s look at AAL as an example:
*If the airline industry collapses and AAL goes bankrupt prior to 1/15/21, we will buy the shares at an effective price of $2.16 a share ($216 for 100 shares), the shares will become worthless and we will lose $216 (per option 1-lot)
*If AAL DOES NOT drop from its current price of $11.65 to the strike price of $3 a share then the option will expire worthless and we will keep the $84 premium as our profit. This represents a return of 38.9% (Column G), which is $84 divided by our maximum risk of $216.
*If AAL DOES drop from its current strike price to the strike price of 3 then we will purchase 100 shares of AAL at $3.00 a share, less the premium received. Our effective buy price will be $2.16 a share.
Now on to today’s idea.
Ticker APRN
Blue Apron Holdings ships food kits to homes – sounds like a winner when no one can go to a restaurant, right? Well in the past 3 trading days a lot of people had that same thought and ticker APRN shot up from roughly $3 a share to $16 a share as you can see at the far right of Figure 1. You will also note that the implied volatility for 90-day options on APRN recently went form its typical range between 80% and 100% to over 300%.
This tells use that there is a ton of time premium in these options, which make them an excellent candidate for the cash secured put strategy.
The difference between this stock and the ones in the previous example is that the stock price is soaring instead of plummeting. Now it is possible that APRN stock will flame out and drop like a stone. But remember, we ARE NOT buying the stock here. We are essentially going to make a bet that if it falls it will only fall so much.
Figure 2 – Ticker APRN – price and implied volatility (Courtesy www.OptionsAnalysis.com)
Our example trade here is:
*Sell 1 APRN Jan2021 3 strike price put @ $2.10
Figure 3 display the details, Figure 4 the risk curves
Figure 3 – APRN secured put details (Courtesy www.OptionsAnalysis.com)
Figure 4 – APRN secured put risk curves (Courtesy www.OptionsAnalysis.com)
Things to Note:
*For sake of example we are simply selling at the bid price of $2.10. A trader might consider using a limit order and trying to get something in the middle of the $2.10 bid/$2.30 ask range
*To enter this trade, we need to have $300 in our account in case the stock falls below the strike price and we have to buy 100 shares of stock at the strike price of $3
*However, we can use the $210 of premium we receive for selling the option as part of this $300. As a result, we only need to put up $90 in cash per 1-lot.
*This $90 represents our maximum risk on the trade
*The implied volatility for this option is an astronomical 340.14%. The hope is that implied volatility will at some point plummet and a great deal of time premium will dissipate.
*The stock trading at $16.25 a share, but our breakeven price this trade is just $0.90 a share
Let’s look at the possibilities:
*If APRN completely collapses, we could end up buying 100 shares at $3.00 apiece. But remember, since we took in $2.10 for each option, we sold our effective buy price is $0.90 a share ($3.00 – $2.10 = $0.90)
*Worst case scenario, APRN goes bankrupt, the shares go to $0 and we lose the full $90 (per 1-lot) at risk
*The most likely outcome (hopefully) is that, either:
a) in 303 days, the options expire worthless and we keep the $210 in premium. This works out to a cool 233.3% return ($210 return / $90 cash held to secure the put options) in roughly 10 months’ time
b) Somewhere along the way implied volatility – and thus the price of the option – plummets, and we can buy back the option early and a price below $2.10 per option.
The bottom line? If APRN does ANYTHING better than collapsing 94% in the next 10 months this trade stands to make a decent return.
Now comes the real question: Is this actually a good idea? As with the previous examples, that’s not for me to say.
Jay Kaeppel
Disclaimer: The information, opinions and ideas expressed herein are for informational and educational purposes only and are based on research conducted and presented solely by the author. The information presented does not represent the views of the author only and does not constitute a complete description of any investment service. In addition, nothing presented herein should be construed as investment advice, as an advertisement or offering of investment advisory services, or as an offer to sell or a solicitation to buy any security. The data presented herein were obtained from various third-party sources. While the data is believed to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Past performance is no guarantee of future results. There is risk of loss in all trading. Back tested performance does not represent actual performance and should not be interpreted as an indication of such performance. Also, back tested performance results have certain inherent limitations and differs from actual performance because it is achieved with the benefit of hindsight.
The good news is that either:
*at some point the carnage may actually let up and the options will collapse in price as implied volatility falls, OR
*the positions will end up buying the underlying shares at levels far below even today’s bombed out prices.
The status of each example position at the close on 3/18/20 appears in Figure 1
A = ticker symbol
B = Closing stock price on 3/18/20
C = Date the put option expires
D = Strike price of put option sold
E = Total $ premium received for writing 1 put option
F = Maximum $ risk per 1-lot (if stock price goes to $0)
G = % gain if option is NOT exercised ($ premium received / $ risk)
H = Effective price you would pay for stock if option is exercised
I = Difference between current stock price and effective purchase price
| A | B | C | D | E | F | G | H | I |
| Ticker | 3/18 price | Option Expiration Date | Put Strike Sold | $ Premium Received (1-lot) | $ Risk (1-lot) | % Return if option NOT exercised | Effective Share Purchase if option IS exercised | Effective Purchase Price from 3/18 price |
| CCL | $9.30 | 4/3/20 | 2.50 | $25 | $225 | 11.1% | $2.25 | (-75.8%) |
| RCL | $22.34 | 1/5/21 | 22.50 | $980 | $1,270 | 77.2% | $12.70 | (-43.2%) |
| MGM | $7.14 | 6/19/20 | 3.00 | $55 | $245 | 22.4% | $2.45 | (-65.7%) |
| AAL | $11.65 | 1/15/21 | 3.00 | $84 | $216 | 38.9% | $2.16 | (-81.5%) |
Figure 1
NOTES:
*Each of the stocks listed is presently in a freefall. Under no circumstances would I advise buying shares of these stocks in this environment
*For each ticker, either a) the stock price will fall below the strike price or b) it won’t
*If the stock price DOES drop below the strike price, we may ultimately be required to buy 100 shares of stock at the strike price. However, our effective buy price (Column H) will equal the strike price minus the premium received
*Column I tells us how far the stock has to fall to reach our effective purchase price. For example, if we ultimately buy, for example, ticker CCL, we will pay an effective price of $2.25 a share, which is -75.8% below the current stock price of $9.30 a share
*If the stock price DOES NOT drop below the strike price, the option will expire worthless and we will keep the entire premium received when we sold the put option (Column E). Our percentage return will be the premium received (Colum E) divided by the maximum $ risk (Column F). The maximum dollar risk is the amount of cash we needed to put up to sell the cash secured put in the first place.
*The % return achieved if the option expired worthless appears in Column G.
*For each of these positions, one of three things will happen. Let’s look at AAL as an example:
*If the airline industry never recovers and AAL goes bankrupt prior to 1/14/21, we will buy the shares at an effective price of $2.16 a share ($216 for 100 shares), the shares will become worthless and we will lose $216 (per option 1-lot)
*If AAL DOES NOT drop from its current price of $11.65 to the strike price of $3 a share then the option will expire worthless and we will keep the $84 premium as our profit. This represents a return of 38.9% (Column G), which is $84 divided by our maximum risk of $216.
*If AAL DOES drop from its current strike price to the strike price of 3 then we will purchase 100 shares of AAL at $3.00 a share, less the premium received. Our effective buy price will be $2.16 a share.
Now on to today’s idea.
Ticker APRN
Blue Apron Holdings ships food kits to homes – sounds like a winner when no one can go to a restaurant, right? Well in the past 3 trading days a lot of people had that same thought and ticker APRN shot up from roughly $3 a share to $16 a share as you can see at the far right of Figure 1. You will also note that the implied volatility for 90-day options on APRN recently went form its typical range between 80% and 100% to over 300%.
This tells use that there is a ton of time premium in these options, which make them an excellent candidate for the cash secured put strategy.
The difference between this stock and the ones in the previous example is that the stock price is soaring instead of plummeting. Now it is possible that APRN stock will flame out and drop like a stone. But remember, we ARE NORT buying the stock here. We are essentially going to make a bet that if it falls it will only fall so much.
Our example trade here is:
*Sell 1 APRN Jan2021 3 strike price put @ $2.10
Figure 1 display the details, Figure 2 the risk curves
Figure 2 – APRN secured put details
Figure 3 – APRN secured put risk curves
Things to Note:
*For sake of example we are simply selling at the bid price of $2.10. A trader might consider using a limit order and trying to get something in the middle of the $2.10 bid/$2.30 ask range
*To enter this trade, we need to have $300 in our account in case the stock falls below the strike price and we have to buy 100 shares of stock at the strike price of $3
*However, we can use the $210 of premium we receive for selling the option as part of this $300. As a result, we only need to put up $90 in cash per 1-lot.
*This $90 represents our maximum risk on the trade
*The implied volatility for this option is an astronomical 340.14%. The hope is that implied volatility will at some point plummet and a great deal of time premium will dissipate.
*The stock trading at $16.25 a share, but our breakeven price this trade is just $0.90 a share
Let’s look at the possibilities:
*If APRN completely collapses, we could end up buying 100 shares at $3.00 apiece. But remember, since we took in $2.10 for each option, we sold our effective buy price is $0.90 a share ($3.00 – $2.10 = $0.90)
*Worst case scenario, APRN goes bankrupt, the shares go to $0 and we lose the full $90 (per 1-lot) at risk
*The most likely outcome (hopefully) is that, either:
a) in 303 days, the options expire worthless and we keep the $210 in premium. This works out to a cool 233.3% return ($210 return / $90 cash held to secure the put options) in roughly 10 months’ time
b) Somewhere along the way implied volatility – and thus the price of the option – plummets, and we can buy back the option early and a price below $2.10 per option.
The bottom line? If APRN does ANYTHING better than collapsing 94% in the next 10 months this trade stands to make a decent return.
Now comes the real question: Is this actually a good idea? As with the previous examples, that’s not for me to say.
Jay Kaeppel
Disclaimer: The information, opinions and ideas expressed herein are for informational and educational purposes only and are based on research conducted and presented solely by the author. The information presented does not represent the views of the author only and does not constitute a complete description of any investment service. In addition, nothing presented herein should be construed as investment advice, as an advertisement or offering of investment advisory services, or as an offer to sell or a solicitation to buy any security. The data presented herein were obtained from various third-party sources. While the data is believed to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Past performance is no guarantee of future results. There is risk of loss in all trading. Back tested performance does not represent actual performance and should not be interpreted as an indication of such performance. Also, back tested performance results have certain inherent limitations and differs from actual performance because it is achieved with the benefit of hindsight.
