We have a strategy which we've run 5 times with a 100% success rate, and an average annualized return of 138.36%. We haven't talked about it very much because it relies relatively heavily on a spike in implied volatility, which up until recently has been nonexistent in the market.
But with VIX starting to creep back up on the heels of the August and September dip in the market, it's finally a decent time to start looking back at some of these opportunities. See below for the VIX resurgence:
Now as we can see... VIX can get much higher, very quickly. This isn't so much to state that VIX is maxed out and we're full steam ahead, but rather this is a good time to start identifying and scaling into some of these LT CSP opportunities. Before jumping into specifics, let's quickly talk about the benefits of this strategy.
Long timeframe - We typically sell these around 60 DTE. Meaning if something moves against us immediately, no big deal. Plenty of time to sit back and let things work themselves out.
Large cushion - By selling longer-dated, OTM CSP's, we give ourselves a really nice cushion between our breakeven price and the current stock price. So if VIX explodes and the market takes a dive, it will still need to fall a decent way in order to get down to the breakeven price we establish. It's a race against time that we win very often.
Flexibility of exit - Just because we sell something 60 DTE doesn't mean we have to hold it all 60 days. If you get a good move in your favor it's pretty common to be able to take 50% of max profit in the first 7-14 days.
Now let's talk specifics. What are we looking for? Ideally we have ALL of these, but it's okay if one of the following criteria is missing if we feel really good about the others.
High implied volatility - This is typically defined as an IV Rank of 90% or greater. For reference, IV Rank is effectively a percentile measure of how the current IV for a stock stacks up against the past calendar year. The higher the IV Rank, the higher the current IV is relative to the past year.
Oversold - Anything under 50 on the 1-year RSI works here, but ideally we like to see 30 or below for that true oversold reading. We want to scale into weakness and use this to our advantage, as a quick bounce could mean early profits.
Identifiable support level - This goes hand in hand with the above point. If a stock is in a downtrend, we want to have an idea of where it might stop. Looking to the left on the chart at historical price action could give us a good idea of what strike we should pick. Does this work all the time? No. No TA does. But I find it's a helpful piece to the puzzle when generating a trade idea.
Good valuation (IMPORTANT) - Saving the most important for last. If all else fails and the stock continues to drop, we want to be comfortable that we're being assigned or rolling options on a good asset. The single best way to do that is through playing a stock that has a good valuation. P/E (price to earnings) ratio is our favorite indicator of this, and if a company is teetering along the edge of profitability then the P/S (price to sales) ratio may also be useful to look at. We NEED the stock we pick to be profitable. That is a non-negotiable. At the end of the day no matter what happens in the market, we can be comfortable that if conditions continue to deteriorate, we've initiated a position in a profitable company and there is some sort of fundamental value in the stock.
With that in mind, let's use that criteria to look at an example and evaluate our most recent LT CSP, -10 M 11/17 10p for a $0.38 credit.
Above is the M 1-year chart. As we can see, it's kind of a nasty chart. There are two of the above criteria that we can quickly identify. Those would be (1) rising implied volatility, as indicated by the blue line below the chart, and (2) the stock is oversold, as indicated by the bottom chart. So right off the bat we have 2/4 items we like to look for in the LT CSP setup.
That leaves us with 2 criteria to be desired. (1) A level of long-term support we can theoretically count on, and (2) a good valuation.
For the first (long-term support), we have to take a look at the 3-year chart:
We can see on the far-left side of the chart that all the way back in November 2020, M breached $10 and then bounced off of it before pressing higher. It's not insanely convincing or strong support, but it's about the best we can do in this situation.
The final and most important point is the one about profitability. Does M have decent value? Are they making money? Let's take a quick look at an overview of M:
As we can see, the P/E ratio is 4.19. That's far below the current S&P 500 P/E ratio of 24.46. So seemingly a good value. However we also want to remember that valuation doesn't work the same for all companies. Macy's is a retailer, so a good P/E ratio for a retailer would be lower than a good P/E ratio for a tech company.
The above link is moreso in the context of a potential M&A transaction, so it may not be the most helpful for this situation with a mature, large retailer. But for research into other areas it's generally a good resource.
Long story short though, 4.19 is a really solid P/E ratio and I would consider Macy's to be cheap, meaning a good value investment. The type of investment we would be comfortable holding in a downturn because fundamentally the valuation is based on concrete earnings. Further, that 4.19 P/E ratio is the P/E ratio at the current price of $10.87. If we were assigned on our 10p, then our breakeven price would be 9.62. At 9.62, Macy's P/E ratio would be 3.71. An even better value.
For all of the reasons outlined above, we believe that Macy's ($M) is a good opportunity for this strategy at the $10 price level. Our position, as previously discussed, is the 11/17 M 10p. But that does leave one final question: Why did we pick November expiry? At the time of our entry the November expiry was 60 days away. There is something unique about that 60 DTE window which give us a little bit of an edge here. See below for a chart showcasing theta decay:
What we'll notice is that all options aren't the same when it comes to decay. The bottom blue line represents OTM, or out-of-the-money options. What we'll notice about these is that at roughly the 60-day mark, the theta decay in an OTM option actually outpaces the others. Seeing as we're targeting deeper OTM options as a part of this strategy, the 60 DTE window is the perfect timeframe for us to sell and take advantage of that accelerated theta decay.
And that's about it. A good quick rundown of our long-term cash-secured put strategy, what to look for, and the ideas behind it which we feel make it successful. These are especially effective at combating downturns in the market so we'll look to expand into more of these positions as the market continues to feel pressure.