Buying Back OTM Cash-Secured Puts on Expiration Friday to Avoid Potential Exercise – December 4, 2023
When cash-secured puts are sold, many investors prefer to avoid exercise and having the shares put to them. If the (originally) out-of-the-money (OTM) strike is in-the-money (ITM) as expiration approaches due to share price decline, buying back that put option will avoid exercise. This article will explore a scenario where the put option is OTM on expiration Friday and the cost-to-close the option is miniscule. I decided to take this path because I could not be in front of my computer to monitor the trade through 4PM ET on expiration Friday. Why not buy back that put option early in the day and not have any concerns of share decline below the put strike by 4 PM ET? This article will also include one of our exit strategies, rolling-up.
Real-life weekly example with NVIDIA Corp. (Nasdaq: NVDA)
- 6/26/2023: NVDA trading at $415.25 (1)
- 6/26/2023: STO 1 x 6/30/2023 $397.50 OTM put at $1.61 (1)
- 6/27/2023: BTC 1 x 6/30/2023 $397.50 put at $0.73 (2)
- 6/27/2023: STO 1 6/30/2023 $400.00 put at $0.98 (rolling-up) (3)
- 6/30/2023: NVDA trading at $416.75 (4)
- 6/30/2023: BTC 1 6/30/2023 $400.00 put at $0.03 (4)
Price chart of NVDA from 6/26/2023 – 6/30/2023
With NVDA trading at $416.75 and the $400.00 strike still OTM, I decided to close the trade at a cost of $3.00 (+0.65 commission) to eliminate the possibility of NVDA dropping below the $400.00 put strike. Although the likelihood of exercise was remote, for $3.65, it was an issue I would never have to deal with. As it turned out, NVDA closed at $423.26 (purple circle).
Initial (pre-rolling) calculations using the BCI Trade Management Calculator
Based on this 5-day trade, the initial time-value return is 0.41%, 29.69% annualized.
Post-rolling results with and without the BTC at expiration
Rolling-up increased the 5-day return from 0.41% to 0.47%, an increase of 14.63% (brown cell). Using the $0.03 BTC on expiration reduced the final return from 0.47% to 0.46%, a reduction of 2.12% (pink cell).
Discussion
When selling cash-secured puts and one of our stated goals is to avoid exercise and the subsequent purchase of the underlying securities, buying back OTM strikes at a miniscule cost should be given consideration. As expiration approaches, the time-value component of OTM premiums approaches $0.00, so the cost-to-close will be negligible, allowing us to avoid the risk of unexpected price movement to the downside risk by expiration.
Author: Alan Ellman