Thread by @IgnoreNarrative

Thoughts on writing puts

Was asked about this by @WealthRemedy and figured I share my view with everyone. Sorry if I misjudged public interest in this.

For those that care about my opinion on the topic, read on

(1/n)

1) I think most people shouldn't write *uncovered* calls or puts, but there are rare circumstances where it can make a ton of sense

2) Covered calls / puts can make a lot of sense depending on the situation (I hardly ever do it but I understand why someone would)

(2/n)

So why did I write uncovered puts on $QRTEA?

Read "You Can Be a Stock Market Genius" if you haven't already. Page 229: Options and Special Situations Investing

Options can be extremely mispriced in situations where there is corporate change, this is a good example

(3/n)

Writing a put is like selling insurance. The best you can hope to get is your premium. But at worst, you can lose a ton. For this reason I dislike insurance and put writing at a fundamental level (I prefer the opposite of this setup)

(4/n)

However, occasionally insurance pricing can become wildly inefficient, and the premiums become exorbitant relative to the risk. In this case selling insurance becomes a gold mine (but again, this is VERY RARE)

(5/n)

Here is the example:

In August I wrote $10.00 puts on $QRTEA. The premium was $2.30 and the term was 15 months. Thats ~18% annualized interest. Historic volatility in the common suggested that was a fair price - I had no view on that.

(6/n)

What I did know is that historic pricing of those options didn't apply to the future. Of that $10.00 strike, $1.50 was about to convert to cash and $3.00 was about to convert to a pref yielding 8%.

The way I saw it, I was not insuring $10.00 of common but $6.00.

(7/n)

Using that thought process, $2.30 of premium to insure $6.00 of common for 15 months, or about ~30% annualized interest was an attractive price, particularly with my view that more cash would be coming back over the insured period.

(8/n)

Sure enough another dividend has now been announced and the insured common strike has dropped from $6.00 to $4.50. That has increased the interest I was paid to take the risk from 30% to 40% annualized.

(9/n)

At 30-40% interest with a strong view on the underlying, I think writing way OTM puts can make a ton of sense. Generally you don't get those chances unless there is some major change that options models don't account for. They are rare but they exist.

(10/n)

Questions? Comments? Pushback? Fire away.