What should I do if my cash secured short put is deep in the money?

Question

Due to the recent market situation, many tech stocks are losing their value real quick. I sold a put last month with strike price $80, and it is going to expire by the end of this month (3 more weeks to go). The stock I am interested to hold has dropped to $75. Since we are in a bear market, it is very likely that the stock price will continue to drop.

However, I am still interested in getting this stock, with an adjusted buying cost (probably $70). Here are several possible solutions I can think of

1. Close my current short put@80 at a loss now, and then sell another put@$70 with the same expiry date to cover up my loss a little bit
2. Sell another put@$70, and hold my existing put@$80 wait until the expiry date of the option. If the stock price is between $70 and $80, then let both of the option to expire to get my stock at a cost of $80. If the stock price is below $70, then I close my put@$80, and get the stock at $70.
3. Close my current short put@80 right now, place a buy limit order at $70 for the stock and wait for a deal.

Which strategy should I use? Is there other better ways to deal with this situation? Or which strategy is the most dangerous one that I should never touch?

I know choice (3) is the most direct way to get the stock, but if there is no deal, I still cannot get the stock at $70. I would like to make my strategy to collect premium if there is no deal.

Answer 1

Since we are in a bear market, it is very likely that the stock price will continue to drop.

Could be, or we could have a nice bounce on the stimulus passing. Predicting direction with consistency would make you very rich.

Ultimately it's up to you to decide what your revised outlook for the stock is and what you want to do about it, but I'll share my initial thoughts on the solutions you've come up with.

2. Sell another put@$70, and hold my existing put@$80 wait until the expiry date of the option. If the stock price is between $70 and $80, then let both of the option to expire to get my stock at a cost of $80. If the stock price is below $70, then I close my put@$80, and get the stock at $70.

This nearly doubles your exposure to the underlying and holding to expiration limits your ability to manage the positions as extrinsic value erodes.

3. Close my current short put@80 right now, place a buy limit order at $70 for the stock and wait for a deal.

This feels like trying to time the market/call a bottom. As you mention, you may never get the deal you're hoping for.

1. Close my current short put@80 at a loss now, and then sell another put@$70 with the same expiry date to cover up my loss a little bit

This is an example of rolling, though I wouldn't roll to the same expiration. If it were me and I was still bullish on the underlying, I'd see how much additional credit I could get rolling my short put out to the next monthly expiring in the 45-60 dte range (usually at the same strike as my original short put). Rolling for a net credit means you further reduce your breakeven. You might be able to roll out a month and down a strike or two and still get an additional credit. You could also pay a net debit to roll further down in strike, just pay attention to your break-even and consider if your play makes sense given your outlook on the underlying.

I don't personally like to roll for a net debit. I either take assignment, roll for additional credit, or close for loss.

Unfortunately the best approach won't be known until after you can do anything about it, that's why some people suggest going into every trade with a plan for how you will exit/manage it.

Answer 2

IMO, an OTM short put should be sold when you want to acquire the stock at a lower target price. If the underlying drops and you have second thoughts, either close the position or make a defensive adjustment. The latter should be done before the put gets ITM and you should sell time for intrinsic value (roll down and out for a credit). And yes, I know that you're already $5 ITM so you may have to sell a lot more time for a credit.

Which strike and expiration to roll to will depend on the strikes offered, whether there are weekly options and the implied volatility. I would prefer the nearest expiration that generates a credit or at worst, a small debit because the decay rate is higher and if some time passes, you can do this again if need be. If you roll out months, you reduce your ability to repeat this and you get time committed (many months out).

For example, a roll down (and out a week or two) to $75 would give you $5 more breathing room, lowering your purchase price if assigned.

Close my current short put@80 at a loss now, and then sell another put@$70 with the same expiry date to cover up my loss a little bit

This reduces your loss but it locks in a loss.

Sell another put@$70, and hold my existing put@$80 wait until the expiry date of the option. If the stock price is between $70 and $80, then let both of the option to expire to get my stock at a cost of $80. If the stock price is below $70, then I close my put@$80, and get the stock at $70.

If the stock is between $70 and $80, you'll be assigned on 100 shares. The cost of the equity will be $80 less the total premium received.

If below $70, you'll be assigned on 200 shares. Your cost basis will be half of ($150 less the total premium received). Now you'll have double the downside exposure.

Close my current short put @80 right now, place a buy limit order at $70 for the stock and wait for a deal.

That just realizes the loss on the short $80 put with the hope that the stock drops more and you get to buy it at $70. That's a maybe that might not happen. So that might mean just a realized put loss on a stock that you want but don't get.

Which strategy should I use? Is there other better ways to deal with this situation? Or which strategy is the most dangerous one that I should never touch?

That depends on hindsight, which none of us have. You have to decide if you are going to bite the bullet (take the loss), adjust with a roll (lowering cost basis), or possibly doubling up by averaging down (sell a $70 put as well).

I'd offer one more possibility for evaluation. If you are more concerned about the downside and you're willing to give up some/all of the upside, see if there is a near term OTM call spread that could be sold for a credit but would not lock in an upside loss (80/82.5, 80/85, 82.5/85?). With the stock at $75, that credit would likely be small but it would modestly lower cost basis.

As a made up example, suppose you initially sold the $80 put for $4 and you could get a $1 credit for the $80/85 vertical. The $1 lowers your cost basis if assigned on the put. That's $5 in premium received and a $5 risk on the call vertical which is break even if the stock rallies to $85. Is giving up the upside worth a $1? Ultimately, you have to decide which potential outcome suits you best and hope for a cooperative underlying.

I'd add that if you're selling premium without the express desire to own the underlying, consider verticals and long stock collars so that you have some built in protection against share price collapse. Yes, the net premium is smaller but the long leg prevents debacles (see last March). It has a much better risk/reward ratio and gives you more ability to defend.