[Music] So, welcome back to the options crash course strategy series. We meet again! My name is Jim Schultz, and in this video, we are going to cover the short put, which is actually a bit of a downtick in difficulty from the short strangle that we just did in the last video.
So that's pretty good! We're going to follow the same protocol that we've been doing: winners, losers, and dance floor. So, let's begin with how a short put sets up.
All right, so structurally and strategically, a short put is actually pretty straightforward. First, it's only a single leg, so that's pretty nice. But second, we are almost always going to choose an out-of-the-money strike on trade entry for a new position, and the reason why is very simple.
By choosing an out-of-the-money strike, we leave ourselves room to be wrong directionally and still make money. That alone is an extremely powerful phenomenon. For example, let's say you've got Starbucks at one hundred dollars a share.
You want to sell a 95 put. Here's how a short put would set up: if Starbucks goes higher, you're going to make money. If Starbucks goes nowhere, you're going to make money.
But even if Starbucks goes down a little bit but stays above that 95 strike, you are still on the path to making money in a market that is very unpredictable and totally random in the 45-day time horizon. This is very, very advantageous. All right, so that's how a short put sets up.
Now, what about these winners? Well, this is pretty straightforward because it's going to be the same as what we've seen with everything up to this point with vertical spreads, iron condors, diagonals, and short strangles. We want to target fifty percent of max profit.
So, you sell the short put for two bucks; you’re looking to buy it back for a dollar. You sell a short strangle or a short put for a dollar eighty; you’re looking to buy it back for 90 cents. It's really that simple.
That's all there is to it. Okay, so now on to these losers—the not-so-fun guys. This is where things can get a little bumpy, so you might want to buckle up.
And, of course, this is not the only way that you could handle these situations, but I do think it makes a little bit of sense. First up: as long as the stock is above your short strike— as long as the stock is above your short put—doing nothing is almost always the move to make. It doesn't matter how you feel; it doesn't matter what you think—doing nothing is the move.
Okay, but let’s say now the stock has fallen down to your short strike. Now what do you do? Well, it really depends on the severity of the move, right?
Like, if the stock is now just below your short strike, then you probably only need to roll out in time—right? Push this thing out to the next cycle, add some duration, pick up some extrinsic value, widen out those breakeven points, and you're probably going to be okay. Okay, but what if the stock has fallen kind of significantly below your short strike?
Now what do you do? Well, first off, as an initial line of defense, you probably want to go ahead and roll out in time, but also, as a secondary line of defense, you might want to consider adding a short call at the same strike as your short put. This would create, for yourself, of course, a short straddle, and it's going to effectively serve the same purpose as rolling out in time.
You're going to pick up more extrinsic value, you're going to help to widen out those breakeven points, but there's another benefit: adding those bearish deltas from the short call will help to flatten out your directional risk—flatten out your directional exposure—from the deep in-the-money or somewhat in-the-money short put that you have and those bullish deltas. This will allow you to focus more on non-directional elements, like theta and like vega, and less on delta. Okay, but what if the stock has fallen way below your short put strike?
Now, again, first off—roll out in time, add that duration, pick up the extrinsic value, widen out those breakeven points. But also, when adding a short call, you probably don't want to go to the straddle strike now. You might want to be a little bit more aggressive.
You might want to go right into an inverted strangle, so your short call strike will be below your short put strike. This will help to more aggressively neutralize those deltas while still bringing in credits, adding extrinsic value, and widening out those breakeven points. The thing you want to be aware of here, and you want to be careful of—as we saw in the short strangle video—is you just want to make sure that the width of your inversion is less than the total credits that you've collected, so you're not locking in a loss for this cycle.
Okay, so now that you've made these adjustments, how do you know when it's time to get out? How do you know when it's time to exit a short put or any undefined risk strategy, for that matter? Well, here are some good rules of thumb: if your position was a loser—which is almost always going to be the case in this scenario—if you can work that thing back to a scratch, if you can work that thing back to even, then I would strongly consider taking it off.
Turning a loser into a scratch is basically like a winner at the end of the day. But what if this thing never comes back? What if the stock never cooperates?
The position. . .
Never accommodates you, and this thing just becomes a runaway train. Somewhere around 2x to 3x of total credits received is a good place to consider exiting your trade if you don't want to hold it anymore. So, just to be clear, as an example, let's say you sell a put for two dollars, and then you make a couple of adjustments; you add some time, and your total credits collected become five dollars.
If you close that trade and it never comes back, and you close it for fifteen dollars, that is a 2x loser. You collected five dollars and you lost ten; that's a 2x loser. If you were to close it for twenty, that would be a fifteen-dollar loser or a 3x loser.
All right, so those are the winners and those are the losers. But what about the dance floor? What about those in-between guys?
When it comes to a short put, well, as is the case with all undefined risk strategies, we don't want to carry these inside of 21 days to go. So, if you still have this on at 21 days to go, the choice becomes simple: you either roll it or you close it. If IVR is elevated and you still like your bullish bias, then consider rolling it.
If IVR has fallen and you don't like your bullish bias, then consider closing it. Well, what if IVR has fallen and you still like your bullish bias? Well, that's your call.
All right, guys, you made it! That is the end of the short put video. Be sure to save this video for future reference, and when you are ready, I will see you in the next video: short straddles.
We'll see you there!
