Covered Call Writing & Selling Cash-Secured Puts: Strategies or Exit Strategies? A Real-Life Example with T-Mobile US Inc. (Nasdaq: TMUS) – August 08, 2022
Covered call writing and selling cash-secured puts are low-risk option-selling strategies seeking to generate weekly or monthly cash-flow. Can these basic strategies be considered exit strategies as well? In this article, I will make the case that, yes, they can be considered both.
When is covered call writing an exit strategy?
After selling a cash-secured put, if the strike is expiring ITM, one of our exit strategy choices is to allow exercise and take possession of the shares with the intent to then write a covered call.
When is selling cash-secured puts an exit strategy?
After selling a covered call, if the strike is expiring ITM, one of our exit strategy choices is to allow exercise resulting in sale of our shares and then using the cash to secure a put sale.
The Put-Call-Put (PCP) Strategy (also called the wheel strategy outside the BCI community): Graphic representation
Real-life example with TMUS (taken from Chapter 27 of my new book, The Blue Collar Investor’s Guide to: Exit Strategies for Covered Call Writing and Selling Cash-Secured Puts
- 4/7/2020: TMUS is trading at $86.09
- 4/7/2020: STO 1 x 5/15/2020 $82.50 OTM put at $2.91
- 5/15/2020: The $82.50 put expires ITM and shares are put to us at $82.50 (less the $2.91 put premium for a breakeven price point of $79.59
- 5/18/2020: Consider the 6/19/2020 OTM $82.50 call strike
- 5/18/2020: Consider the 6/19/2020 ITM $77.50 call strike
Initial put trade returns
Using the BCI one-of-a-kind Trade Management Calculator (TMC), we see that the initial return on the put option sale is 3.66%, 34.22% annualized based on a 39-day trade. Shares are put to us if the strike moves ITM at expiration and we take no action to close the ITM short put. TMUS is purchased at a breakeven price point of $79.59 or a 7.55% discount from the share price when the put sale was initiated.
Initial covered call trade returns if shares are put to us at $79.59
The OTM (from the perspective of the breakeven price point of $79.59) $82.50 call strike (red arrows) shows an initial time-value return of 2.89%, 31.96% annualized based on a 33-day trade. There is also an upside potential of an additional 3.66% if share value moves up to or beyond the $82.50 OTM strike. The breakeven price point is $77.29.
The ITM $77.50 call strike (blue arrows) shows an initial return of 2.79%, 30.83% annualized based on a 33-day trade. There is also downside protection of the initial time-value profit of 2.63%. This means that if share value declines by 2.63% or less, we are guaranteed that the initial 2.89% time-value profit will be realized.
Discussion
Covered call writing and selling cash-secured puts are low-risk option-selling strategies. They can also serve as exit strategies for each other. The goal of the PCP strategy is to generate cash-flow. Each leg of the trade will accomplish either premium returns or purchasing a stock at a discount. Since there is a breakeven price point associated with each leg of the trade, there is risk that share value can decline below that price and we can start to lose money. We must always be prepared with our exit strategy arsenal to mitigate losses, enhance gains and turn losses into gains.
Alan Ellman