RE: Shorting Put Leaps
I have written naked puts, including LEAPS, though never as deep in the money [DIM] as suggested by lurker. Currently I'm short some Intel Jan '03 40 puts, which, I am unhappy to report, have just gone slightly in the money.
First of all, as Ian suggested, yes, these are "American style options", hence they may be exercised at any time by the opposite party who is long the put.
Lurker's idea is intriguing since the income generated from selling DIM puts is much greater. OTOH, the time premium that the seller of DIM puts realizes is typically much less.
For example, let's compare the AMAT Jan '03 50 put to the AMAT Jan '03 130 put:
The 50 is trading around 14, so with the stock at 54, the time premium is 18 [check: 50-14=36=breakeven=18 below 54 PV of AMAT]. However the 130 is trading at about 76 (with wide spread as noted by Ian) hence time premium is nil.
So there's the tradeoff: The DIM put writer trades income for time premium. And I would argue that this income stream is rather uncertain, for the reason that Ian mentions, i.e., the risk of exercise. Although the conventional wisdom is that puts are rarely exercised early, the reason for this is that to exercise the puts usually costs the put buyer time premium. Where there is no time premium, there is no disincentive to early exercise.
I would argue that the income inclined AMAT bull would be better off writing the Jan '03 50 put instead of the 130.
It is true that he would only collect a premium of $1,400 per contract, rather than $7,600 for the 130 strike. However, the 50 put writer has lowered his breakeven price from 54 to 36. I would reason that even if AMAT were to get down to such a depressed level, it would probably not stay down there for long.
The leap put write thus serves a double function for me: (1) it generates a moderate amount of income in return for taking a tolerable amount of risk and (2) it enforces a discipline that forces me to be prepared to buy on an extreme dip, which may be psychologically difficult to do ordinarily. I often rationalize it as being paid an income stream in return for entering a ridiculously low limit buy order that is non-cancelable. I especially like knowing that my breakeven price is x% below the current market price.
That said, my naked put writing experience is somewhat limited, and I am sure that one day I will pay some tuition on it. <G>
One final point. Lurker mentioned a margin requirement of 20% in equity. I believe there is also a maintenance margin requirement of 50% of the current value of the stock. This becomes important if you are trying to maximize the margin potential of your account. Often it creates an incentive for the put writer to liquidate a favorable position early rather than simply waiting for it to expire worthless, because this maintenence margin is seemingly unfairly linked strictly to the price of the stock, even though there may be very little time left on it and it may be way out of the money.
Hope this is not too confusing and that it answers more questions than it raises.
Sam |
