Trading the R Put Sales
Trading the R's
How to calculate when selling put options
Many analysts and companies make this more complicated than it needs to be. I will say simply, if you need a rough, quick, down and dirty way to calculate risk on an option trade, this formula works. It's at least close enough, and the reason I say that is because options can change and fluctuate in price regardless of what the stock does.
Put Stop placement = (Strike price of put sold) - (premium received) - [ R / ( # of contracts x 100 shares) ]
Selling puts is a bullish strategy. To learn more about put sales, watch this class:
Below is the best way I've found to sell puts and still have an understanding of risk mitigation.
First, ask yourself, 'What is my R'? In my opinion, only traders with a larger R should sell puts. Put selling usually requires an account over $40k, and it depends on the broker and the experience of the trader, of course.
Getting to the point.
Let's use stock NQ as an example. Let's say the student has no issue getting put the stock. That trader sells 10 of the $5.00 July puts for $0.25 limit. This would make the dollar cost average $4.75 if the trader was put the shares.
Say this trader has an R of $400.00
The trader would determine the loss price from the dollar cost average location of where they would get put the stock. 10 contracts controls 1000 shares.
If NQ closes below $5.00 on the 3rd Friday in July, the trader would get put the shares. 1,000 shares to be exact at a dollar cost average of $4.75, which would be a cost of $4,750. Let's determine the stop price needed on the stock using the above formula.
Put Stop placement = (5) - (.25) - [ 400 / ( 10 of contracts x 100 shares) ]
Put Stop placement = 4.75 - [ 400 / 1000 ]
Put Stop placement = 4.75 - .40
Put Stop placement = 4.35
Meaning If the stock dropped $0.40 cents, from $4.75 (the dollar cost average) to $4.35, that would be a loss of $400.00 (the trader's R).
If the above trader got put shares at $4.75, I would, therefore, conclude my stop for this put sale should be at $4.35.
Please keep in mind, there are inherent risks with all trading. For example, if a trader sold the $5.00 put on NQ and brings in .25 of premium, if the stock gapped down over night to $2.00, the trader would be looking at a loss of $2.75 per contract, which is well beyond the R.
Another possibility to consider for a stop loss. Alternatively, the trader can buy to close the sold put anytime before expiration to remove obligation and risk. Meaning, if the trader sold the $5.00 put (while NQ was at $6.00) and then NQ increased to $7.00, the put sale would likely decrease from .25 to say, .10 cents. If the trader wanted to simply buy to close the sold put, they would realize a gain of .15 cents, minus commissions of course. This strategy can be very effective for weekly put sales if trying to capture a few cents on a bullish pop on a stock.
Above is the put sale in the formula listed. I'm not 100% sure about the following statement, but I do believe this is the first formula example of put sales, in combination with an R (risk unit) strategy. It's the first one I know about, at least, although there could be hundreds . . . Regardless, I'm not here for fame. I'm simply here for education and enrichment!
I always give credit when it's due. Two Real Life Traders helped immensely in this project. Victor Gonzalez and Zane Whitener. Thank you, Gentleman! Onward and upward from here. Again, never sell a put option without fully understanding the risks. If you ever have any questions, feel free to email me anytime! firstname.lastname@example.org