There are three skills we employ in our options trading system: (1) stock selection; (2) options selection; and (3) trade management. We are going to talk about (3) in this post. We've discussed it before, but it never gets enough attention.
The market had a volatile week and we've explained a little bit why we don't worry too much about that. We currently have 34 open positions, and only two of them are within 20% of the money. In other words, the stock would have to fall more than 20% before these even begin to see losses. On average, our trades are about 36% away from the money.
But, because many of you asked about the two trades that are approaching the money line, we are going to discuss them here: our SOS and GMBL puts.
On February 16, we sold SOS $5 M19 puts for $0.35 with a target exit of $0.15. At the time, SOS had shot up to over $11 due to, among other things, its construction of a bitcoin mining facility. But since then, it has tanked and is now down to a lowly $4.77. Why? Some short seller posted a tweet on Friday asserting that SOS was a Chinese shell company.
Does this mean SOS is an SOS? Not yet it doesn't. See that dog on this post's cover image? He thinks he is drowning but he's only sitting in 2 inches of water. Don't be like that fella! Everything is fine.
We note as a threshold matter that short sellers post crap like that all the time and it's not always true. Sometimes it is, sometimes not. Obviously, their desire is to drive the stock down, and with SOS they succeeded. But is there merit to their tweet that will last more than a day or two? We don't know and we don't really care. We don't like to guess about these things.
"How can you not care?" you ask. "Don't you care about losses?" Of course we care about losses, but we don't see that as likely right now. No matter what happens to SOS, we believe there is a high likelihood that we can manage this trade successfully.
First of all, the position isn't even in the red yet. Why not? We sold a $5 put for a $0.35 premium, so our breakeven is $4.65, and SOS is above that at $4.77. If SOS doesn't go below $4.65 by March 19, then we will have a gain. When you look at the price of the put now and you see it's a whopping $1.50, remember that only $0.23 of that is intrinsic value. The rest is all time premium. And time premium always decays eventually.
Second, there are weekly options on SOS, rather than monthly, which means we have even more flexibility than usual. We can roll week-to-week and capture more and more premium. For example the $5 puts expiring March 26, just one week after M19, are about $0.15 more expensive. That means we could roll $0.60 a month off of our breakeven point. That's more than 10% a month for a $5 put.
Third, SOS's low price puts a psychological brake on how quickly it is likely to drop. Just as a general matter, $3 stocks tend not to fall as precipitously as $300 stocks.
Fourth, we see that SOS has been in business for years and rarely falls below $2. That might seem like a really low price, but even if it fell to $2, we could roll put options week to week and get there in a little over three months at the $0.60 per month rate, so maybe four months at a more conservative rate. Moreover, this assumes there aren't any bounces along the way, which would be highly unlikely. Because we think a bounce would be highly likely as we roll, we therefore think it would be highly likely that we can recover this trade into a win. It probably won't be as good a rate of return as our usual trades, but a win is a win.
Fifth, relatedly, there is a lot of time between now and the M19 expiration. The stock might bounce and trigger our exit. That doesn't seem likely to happen next week, but the following week maybe. That will likely be the next time we consider what to do about SOS.
In the meantime, because we have all this time and flexibility, we just won't worry about it. Selling options lets us manage trades in ways that long positions just don't allow. And it has fundamentally changed our attitude about investing for the better, i.e., much lower stress.
Similarly, one of our subscribers expressed some concern about GMBL. That one is also fine. It is currently almost 15% above the breakeven point, and so it has a long way to go before we start to see a loss. We have several weeks left until expiration and time decay is in our favor. And, the April puts are $1.20 more expensive than the ones we sold for March, so we if have to roll, there's lots of premium for the taking.
This brings us back to our main theme: don't worry. Our trades are looking a-ok and we are excited for what March will bring!
Marc and Laura