A fellow trader sent me this question. Folks new to options trading can easily be confused when they open a cash secured short put in their account. (These are allowed in retirement accounts.)
Knowing what kind of impact these have on your overall bottom line in your portfolio is important to your comfort level. Paper trading is a safe way to learn the options’ behavior.
Q:
I finally decided to pick a few stocks to sell OTM Puts, which I did. All good fundamentals, and I reviewed their trend lines over the last year on the technical charts. So, I feel I made some safe/attractive potential buy areas.
Having said that, you obviously take in a credit when you short puts….but I’m confused when/how/where you see that in your account? Theoretically, you want them to expire “worthless” to retain your credit (or you long the stock…I get that). BUT, I’m not sure where to look except my account history to see the positive impact. Does it not happen until expiration? What confuses me there, is the value could actually look “negative” if the PUT gets bullish since it reflects a “credit” rather than a debit? I’m confused and need to know what to expect between now and expiration.
A: The affect on your account fluctuates during the life of the obligation on the short put (from position open to expiry.) If the value of the option rises, you’ll show a LOSS in your account. (You could have received more credit at that moment because the stock price fell or the Implied Volatility [IV] rose, causing the option to increase in value.) If the value of the option falls, you’ll show a GAIN in your account.
Of course, theta will make the value of the option drop each day until expiry, but the change in stock price and IV can offset that drop in value due to theta.
The final result on expiry Friday is the real key.
Say you sold a put at 2.00 credit and the stock price declined and the IV rose pushing the value of the option to 5.00…. showing a loss of 3.00 per share on your account total. At expiry, the stock is assigned to you at the strike, you keep the credit you received for the short put and have a cost basis less than the assignment price due to the credit you received. You’re account total will reflect a loss on position because the short put is gone and the stock price is below the assignment price (strike of the SP.) The portfolio total will have risen by the amount of the credit you received upon the entry to the short put position and dropped by the difference in the strike price (at assignment) and the current stock price.
Hope that helps.
OptionsANIMAL Instructor
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