How to Establish a Bear Market Cash-Secured Put Trade


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In bear and volatile market conditions, we may opt to take a defensive posture with our cash-secured put trades. One technique to accomplish this conservative approach is to use implied volatility (IV) to determine an approximate trading range for the option contract expiration period and use a put strike near the low end of the range.

Implied volatility and projected trading range: Process

  • Locate an at-the-money (ATM) put strike, and the implied volatility associated with that strike.
  • IV is based on 1 standard deviation (approximate 68% accuracy). Of the 32% that falls outside this range, we are concerned only about the 16% that will fall below the low-end of the range. This creates an approximate 84% probability of avoiding exercise, or the strike expiring in-the-money.
  • Since IV is an annualized statistic, we must use a conversion factor to generate an IV specific for the option contract in question.
  • The BCI Expected Price Movement Calculator has such a conversion factor inherent ion the spreadsheet.

Real-life example with Futu Holdings Limited (Nasdaq: FUTU): Put option-chain on 10/4/2023

  • 10/4/2023: FUTU trading at $54.80 (FUTU is an eligible security on our BCI Premium Stock Report on this date).
  • The near-the-money (close to ATM) $55.00 put strike shows an IV of 0.50 (50%- yellow cell on the right).
  • Using the BCI Expected Price Movement Calculator (see below), we determine the low-end of the trading range is approximately $46.81.
  • The $47.00 put strike shows a bid price of $0.56.

BCI Expected Price Movement Calculator Results

  • This will be a 31-day trade, if taken through contract expiration.
  • FUTU is expected to move up or down by no more than $7.99, 84% of the time, during the contract.
  • The low end of the range will lead us to the $47.00 put strike (purple circle), which showed a bid price of $0.56 in the 1st screenshot.

Initial calculations using the BCI Trade Management Calculator

  • This is a 31-day trade, if taken through contract expiration (red circle).
  • Initial time-value return is 1.21%, 14.20% annualized (brown cells).
  • If exercised (expires in-the-money with no exit strategy implementation), shares will be purchased at a 15.26% discount from the price at trade entry (pink cell).

Discussion

In bear and volatile market conditions, we can utilize IV and the BCI Expected Price Movement Calculator, along with the BCI Trade Management Calculator, to establish our defensive trades that will frequently still results in significant annualized returns.



Exit Strategies for Covered Call Writing and Selling Cash-Secured Puts

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Selling Cash-Secured Puts: Multiple Applications

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