Selling puts with the aim of capitalizing on inflated implied volatility prior to an earnings release counts as an investment strategy only for those who would be willing to own the underlying stock outright.
If you happened to have followed the approach of writing May puts against Tesla Motors (TSLA) prior to the company’s quarterly earnings announcement — when the company was trading for a little over $57 per share — you benefited tremendously from the subsequent short squeeze which pushed the underlying stock to $91.50 by Friday’s close and drove the value of the puts to zero. (See “Extreme Investor Worry in Pre-Earnings Options Pricing: Is Tesla Like Apple?”.) That’s a tidy gain of around 20% relative to collateral requirements for the May strike, or if you sold June puts instead, you’ll be awaiting gains of 15% to 28%, should the stock remain above the 55 or 57.50 strikes, respectively, by June expiry.
As I noted the next day (“Follow-Up After a Successful Naked Put Write on Tesla”), the unhedged approach of simply buying the shares outright would have captured a larger gain — a gain which now is knocking on the door of 60% — and would have done so in the same amount of time, just 9 days. However, it’s worth revisiting the question of why an investor might have chosen options over the outright equity purchase in the first place.
A large part of the incentive was the high level of implied volatility, which made the short puts expensive. With such a relatively brief time to expiry and with the expected decline in implied volatility after the earnings release, their value could be expected to evaporate quickly, should the underlying stock move up or remain the same. (The same reasoning about option pricing explains why simply buying calls was less appealing.)
But there are important additional differences between owning the stock and selling the puts:
- selling puts creates a hedged position, providing some downside protection in the form of the option premium received, and
- selling puts requires a far smaller collateral commitment than the outright purchase.
On their own, these differences can make selling puts attractive to investors and speculators alike. However, the approach should only be considered an investment — as distinct from speculation — for someone who is already happy to own the stock anyway. The shape of the profit/loss graph is, after all, identical to that of the covered call, where an investor sells calls, usually out of the money, against stock which he or she already owns. In the absence of a willingness to accept the risk that the stock will decline, the short put is of course unattractive. (In my view, the strategy is particularly appropriate where one already has a long position in the underlying stock and would be happy to add more, in which case it works much like hedging only part of the equity position by selling calls against it.)
In other words, selling Tesla puts, just like Apple puts before them (“With Apple Investors Worried, Pre-Earnings Option Pricing Looks Like an Opportunity”), may represent an attractive approach specifically for investors who believe that options prices are inflated because of undue worry about price moves subsequent to earnings but who are also willing to accept the risks that come with owning the stock outright.
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