I should give an update for my experiment with selling cash-secured put options.
Back in June 2012, when the percentage of my portfolio invested in stocks was close to reach a trigger point for rebalancing, I wrote this post: Sell Cash-Secured Puts: Get Paid for Your Rebalancing Commitment. The gist was that by announcing to the market your firm commitment to rebalance, you receive a payment from the other market participants for your commitment. If you just keep the commitment to yourself and not tell anybody, you get nothing.
I did follow through with real money. My investments in emerging markets were closest to the trigger point. So I sold 2 put options on iShares Emerging Markets ETF (ticker EEM) with a strike price at $35 expiring in 45 days for $150. EEM was selling at $38 at that time. I said if emerging markets dropped another 8% I would buy.
EEM did not drop to $35. The lowest it ever got after I sold the put options was $37. The put options expired worthless. I kept the $150 option premium, which came out to 2% on the $7,000 cash I set aside for 45 days. Because I was committed to buy anyway, the 2% option premium was just extra money for announcing it. Earning 2% in 45 days was much better than earning 1% in a full year in a savings account.
I also sold 4 put options on EEM at $34 expiring in six months. I received $840 in option premiums, or 6% of the price of the underlying security. EEM never got to $34. I kept the 6% for making the commitment for six months.
(1) Committed to buy at $35 until July 22, 2012.
(2) Committed to buy at $34 until December 22, 2012
Altogether, I made close to $1,000 for something I was planning to do anyway: buy more if prices go down. Announcing the plan made the difference. I provided value to the market. The market paid me for it.
It would be better to buy emerging markets outright when EEM was at $38 — today it’s selling at $44, a 15% gain — but at that point it hadn’t triggered rebalancing just yet. Buying at $38 would be taking a different kind of risk than committing to buy at $34 or $35.
My takeaway from this experiment:
1) Selling cash-secured put options works best when the price is close to trigger a buy to rebalance but not quite yet. Fearful investors are willing to pay a good price to have a committed buyer.
2) Use this strategy only when you are truly committed to buy at the set price. Don’t speculate.
3) Selling longer-term options is more profitable than selling shorter-term options but it’s also more risky. Had the price gone below the strike price but the puts didn’t get exercised, I would have missed the opportunity to rebalance.
4) It works best in a sideways market. When prices fluctuate sideways, you just keep collecting the premiums; meanwhile a traditional long-only portfolio doesn’t go anywhere. Now that stock prices are up quite a bit, the opportunity to sell put options at that low strike price no longer exists.
Again I’m not recommending this to anyone. It was just an experiment. Luckily it worked out well.
[Photo credit: Flickr user SalFalko]