Jim, How do you calculate time value, using margin or other?
Stock price = P
Strike price = S
The bid for the contract = B
So, I assume that I can sell for B, meaning if assigned my entry price is (S-B) = my max capital at risk. (that’s what I’d lose if the stock went to zero)
Assuming it is out of the money, the maximum profit is the same as the bid, B.
So the raw return is B/(S-B).
I then annualize that by multiplying by 365/(days to expiry).
I hope for more, but never do it for under 15%/year rate.
I don’t try to maximize this…I want the biggest margin of safety (long date, low strike) that gets me a decent number, say 15-22%/yr.
The nice thing is you can do all this math before you enter a position, and just say no if it isn’t interesting.
Using a limit, as one should always do, usually you do a little better than getting just the bid, but I don’t count on it.
I don’t assume any leverage when assessing a position.
Going into the position you need to have availability of (S-B) in cash in case of assignment.
(after you collect the premium, you need just S of course).
But it’s not too crazy to assume you’ll never have all contracts assigned the same day.
So though I ensure that I have enough for most contracts to be assigned the same day, you can get by with less than enough for ALL of them to be assigned.
(especially since worst case you’d use broker margin for a couple of hours till you sold the stock and replaced it with fresh puts)
Unless the maximum remaining rate of return is very low, I don’t close positions early.
I prefer to have them assigned, as that means I don’t have the horrible option contract bid/ask gap to pay to close the position.
Trading the stock is much easier and cheaper, so I prefer assignments.
Ideally assigned with just a few cents in the money, but then a nice bounce Monday morning before I sell it : )
I find that over time the return you get from repeated cash-backed put writing (without leverage)
will tend to be about halfway between the return on the stock in that time period, and around 10%/year rate.
If the stock is returning 10%, it’s a wash.
If the stock returns 16%, you might make 13%.
If the stock breaks even, you might make 5%.
If the stock loses 10%, you might break even.
A bit better if your picks are good, and/or if you are really careful about not doing it when the premiums on offer aren’t good.
Price matters a whole lot:
Picking up pennies in front of steamrollers is a bad idea.
But picking up gold coins in front of Tonka trucks is fine.
Jim