Using The Put-Call-Put (PCP) Strategy to Create Downside Protection on Steroids – June 6, 2022
Covered call writing and selling cash-secured puts are low-risk option-selling strategies that lower our cost-basis and generate cash-flow as we seek to beat the market on a consistent basis. By integrating both strategies, we construct a multi-tiered option-selling strategy which will both generate significant cash-flow plus offer substantial downside protection. In our BCI community, we refer to this strategy as the Put-Call-Put or PCP strategy. Outside our community, it is sometimes referred to as the wheel strategy. This article will highlight how The PCP strategy can result in huge downside protection over a 2-month timeframe using T-Mobile US, Inc. (Nasdaq: TMUS).
What is the PCP strategy?
An out-of-the-money (OTM) cash-secured put is sold and, if exercised, we write an in-the-money (ITM) or out-of-the-money covered call. Here is a graphic representation of the strategy:
The initial put sale on 4/7/2020 with TMUS trading at $86.09 (5-week return)
The OTM $82.50 put strike shows a bid price of $2.91. This premium can probably be negotiated higher, leveraging the Show or Fill Rule, but we will use the published bid price.
Put leg of the PCP trade
- Initial 5-week time-value return of 3.66%
- If exercised, shares are purchased at a 7.55% discount
- The breakeven price point is $79.59
Covered call leg of PCP trade
- The OTM covered call generated an initial 5-week return of 2.90% with an additional 3.70% of upside potential
- The ITM covered call generated an initial 5-week time-value return of 2.80% with 2.60% downside protection of that time-value profit
- The ITM call strike resulted in a 5.2% protection to the breakeven price point
Downside protection of steroids (12.75% over 2-months (7.55% + 5.2%)
In this real-life example, the stock price would have to drop more than 12.75% over 2 months before a penny is lost.
Discussion
Covered call writing and selling cash-secured puts lower our cost-basis and provide protection to the downside. By combining the 2 strategies into the PCP strategy, we can create huge downside protection or downside protection on steroids.