Risk-Reward Profile When Rolling-Up Our Cash-Secured Put Trades – November 20, 2023
One of our available cash-secured put trade exit strategies is rolling-up to generate an additional income stream (or multiple income streams). The disadvantage of this position management approach is that we are bringing the strike closer to current market value, enhancing the possibility of exercise. If avoiding exercise of our short puts is inherent in our strategy approach, we must understand the risk involved and compare that to the potential reward. In this article, a real-life 4-day trade with NVIDIA Corp. (Nasdaq: NVDA) will be highlighted.
NVDA trades
- 6/20/2023: NVDA trading at $429.44
- /20/2023: Sell-to-open (STO) 1 x 6/23/2023 $410.00 put at $1.54
- 6/20/2023: Buy-to-close 1 x 6/23/2023 $410.00 put at $0.82
- 6/20/2023: STO 1 x 6/23/2023 $41500 put (roll-up) at $137.00
- 6/23/2023: The 6/23/2023 $415.00 put expires out-of-the-money and worthless
Broker screenshot of NVDA trades
Note that the $415.00 rolled-up strike showed a Delta of 13 when viewing the option-chain. This means that there is an approximate 87% probability that the strike will expire out-of-the-money and worthless at expiration. This would be a desirable result for most put-sellers who do not want to take possession of the underlying security or initiate exit strategies to avoid exercise.
Pre- and post-adjustment calculations with the BCI TMC spreadsheet
- Brown cells show a pre-adjustment return of 0.38%, 34.40% annualized
- Purple cell shows a post-adjusted 4-day return of 0.51%, 46.54% annualized. This represents an improvement of 34.2%, due to rolling-up
- The Trade Journal entry archives the steps taken to achieve the final results
Discussion
When adjusting our option trades, we must understand the pros & cons or the risk-reward components of our trade adjustments. In this NVDA example, there was an approximate 13% risk of the option moving in-the-money and subject to exercise, while providing the opportunity of enhancing returns by 34.2%. Once these potential outcomes are understood, we can make an informed decision as whether we want to move forward with this exit strategy.
Author: Alan Ellman