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Put Writing as a Cure for ‘Shoulda’ Syndrome

October 01, 2009 | About:
What is ‘Shoulda’ Syndrome?

Watching a stock that you liked go up day after day without ever have pulled the trigger and bought some shares [e.g.- I shoulda bought Apple, Google, etc. back near the lows].

‘Shoulda’ is a first cousin to buyers’ remorse (where you purchase something- only to find out later that you wish you hadn’t).

How can writing [selling] puts cure this dreaded disease?

Read on.

We’re all guilty of watching stocks we like go up without us having gotten on board. Then we face the excruciating agony of having to decide whether to bite the bullet by paying more than we needed to, or to risk self-loathing due to watching our pick go up even more while we still don’t own it.

How many times have you said to yourself “If XYZ ever comes back to $20 /share I’m loading up the truck”? Put writing can take some of the sting out of those situations.

Here are the end of June and current prices on a few well known stocks.

Company ................. .Jun. 30, 2009 Close ....... Sep. 30, 2009 Close .......... 3- Month Gain

Apple [AAPL] .................. $142.43........................ $185.35 ........................ 30.1%

Coach [COH] .................... $26.81 ......................... $32.92 ........................ 22.8%

Hewlett Packard [HPQ] ...... $38.65 ......................... $47.21 ........................ 22.1%

Best Buy [BBY] ................. $33.35 ......................... $37.52 ........................ 12.5%

Instead of lamenting having missed the moves consider selling puts that would get you back in only if you could buy at the earlier price points. Here are some actual quotes on puts with the above stocks and the resulting break-even prices you would pay if the options are exercised later.

Company ..................... Jan. 2011 Put Prem. ....... Net Cost (if put) ......... Margin of Safety

Apple [AAPL] ................ $165 put = $22.50 ........... $142.50 ..................... 23.1%

Coach [COH] .................. $25 put = $3.00 ............... $22.00 ..................... 33.1%

Hewlett Packard [HPQ] .... $40 put = $3.80 ............... $36.20 ..................... 23.3%

Best Buy [BBY] ............... $40 put = $8.60 ............... $31.40 ..................... 16.3%

You can clearly see that even if your puts are exercised you’d be buying at, or below, the prices you missed back near the end of June when the overall market was much lower. If the puts you sell expire worthless you won’t buy the shares, but you’ll have been well paid by keeping the premiums collected. If you do get exercised, you’ll end up owning the shares you wished you’d bought earlier, at prices that haven’t been available recently.

I have three rules to always keep in mind when writing puts:

 Only sell puts on shares you think are worth owning at the net exercise price.

 Write only as many puts as you’d be comfortable having exercised.

 Maintain adequate cash and/or buying power reserves in your account to allow for adverse market action.


Disclosure: Author is short puts on AAPL, COH and BBY from earlier this year.

About the author:

Dr. Paul Price
http://www.RealMoneyPro.com
http://www.TalkMarkets.com

Visit Dr. Paul Price's Website


Rating: 3.7/5 (10 votes)

Comments

bearuo
Bearuo - 4 years ago
Doc, thanks for emphasizing some important aspects of put writing. Kindly consider writing another article - "Shouda Bought Calls Instead of Selling Puts".
batbeer2
Batbeer2 premium member - 4 years ago
>> We’re all guilty of watching stocks we like go up without us having gotten on board.

Ehm..... how do you know this ?

I believe the cure is not selling puts but focussing on value. Just buy the best opportunity out there. If the best you can find does not offer a significant margin of safety.... continue searching. If this is too hard.... let someone with more talent do it for you.

IMHO selling puts has never cured anything.
cm1750
Cm1750 premium member - 4 years ago
I think puts should be used to some extent - if there is nothing you really want to buy (times like now) and have cash, selling puts on stocks at prices you want to buy it at is a good idea. The risk is, as Bearuo mentioned, that you can only make the premium, forgoing potentially huge upside if the stock takes off - however, I think that is less likely as most stocks are fairly valued or overvalued (quality large caps being the exception IMHO).

If you have 30% cash, selling significantly out-of-the-money puts will allow you to earn premiums on that cash, possibly adding 10% annual returns (depending on VIX) on cash balances. Caveat - Do NOT do this if you are fully invested as markets/stocks can always fall far below fair value.

Warren did that on BNI last year, selling O-T-M puts at $80 if I remember correctly and collected around $6 premium.
Dr. Paul Price
Dr. Paul Price premium member - 4 years ago
Batbeer,

Buffett often uses puts to buy more shares of stocks he likes. He's recently done so in a big way with BNI to increase his position.

Obviously, he does not agree with your view.
expectingrain
Expectingrain - 4 years ago
I agree with your approach, but I think you'd be better off using shorter term puts and taking advantage of the time decay.
batbeer2
Batbeer2 premium member - 4 years ago
I see...

Anyone selling puts does so as a cure for the 'Shoulda syndrome'.

Your logic escapes me.
kermtapi
Kermtapi - 4 years ago
Exellent educational piece. Thanks so much for your contributions to other investors.
buffetteer17
Buffetteer17 premium member - 4 years ago
There's one flaw in this idea. Puts themselves are investments. As such their value varies inversely with the underlying security, thus a short put position will vary directly with the underlying security. If you sell a put on a high-priced stock and the stock declines, so does the value of your put option position.

The time to sell puts is when the underlying stock is not far above your buy price. This is when the puts have maximum value. You also will want to check what the option implied volatility is and make a judgement if it is too high or too low. You want to sell when you think the volatility is not too low.

If you missed the low price on some stock you're interested in, that's water under the bridge. Rather than sell a put when the stock is high, just keep the stock on your watch list. Sell the put when there's a pullback in the stock to a level not much above your buying price, say 10-20%.
bearuo
Bearuo - 4 years ago
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